Signalling a major change in the way dividend income is taxed, the finance minister, Arun Jaitely proposed in the Union Budget for 2016-17 that if dividend income earned by a resident individual, HUF [Hindu Undivided Family] or firm exceeds Rs 10 lakh, it will be taxed at the rate of 10 percent in the hands of the recipient.
This is over and above the dividend distribution tax [DDT] currently paid by firms @ 16.995 percent [inclusive of surcharge and education cess] of the dividend amount so declared, distributed or paid. With the grossing up [as per Finance (No.2) Bill, 2014, dividend paid is grossed up with income distributed for computing DDT], the effective tax rate is even higher at 20.47%.
The policy in regard to tax on dividend income had a chequered history with successive governments oscillating from one extreme to another. Thus, prior to 1997-98, tax was levied in the hands of the recipient when P Chidambaram then, finance minister [FM] switched over to DDT @ 10% which was subsequently increased to 12.5%.
The position was reversed in 2002-03 when Yashwant Sinha then FM under NDA–dispensation restored tax on dividend income in the hands of recipient with increase in threshold limit for exemption from TDS [tax deducted at source] from Rs 1000 to Rs 2500. Meanwhile, a committee under Dr Vijay Kelkar was set up to examine the issue de novo.
In 2007-08, based on the recommendations of Kelkar Committee, the then UPA – government resurrected DDT but with increase in tax rate to 15%. Since then, DDT has continued till date with effective rate increasing to 20.47% [courtesy, surcharge, cesses and change in method of calculation as per Finance bill, 2014].
With the proposal in 2016-17 budget, for the first time ever, we have DDT on distributed profits co-existing with tax on dividend income in the hands of recipient. Such a tax regime suffers from several anomalies.
At the outset, when a corporate entity has already paid income tax [or corporate tax, common parlance] on its profits from business, the very idea of taxing dividend income – a portion of net profit [after payment of tax] allocated for distribution among the shareholders is flawed. How can the same income be taxed twice?
All shareholders put together constitute the body corporate. The fact that the two are ‘inseparable’ cannot be wished away
simply because the latter is incorporated as a distinct entity which is for the purpose of conducting business and meeting statutory obligations. Therefore, taxing the same income twice first on corporate profit and then, as dividend income is untenable and unjustified.
For a moment, let us grant that a shareholder can be distinguished from a company albeit for the purpose of tax [being done for ages]. Then, logically it should be taxed in the hands of the recipient instead of levying tax at the point of distribution [read DDT]. Yet, by taking recourse to the latter, the government would be violating a basic tenet of direct taxation viz., “progressivity”.
This principle requires that persons with lower income are taxed at lower rate, while those with higher income pay at higher rate. This is followed for taxing personal income with rates varying from 10% to 30% depending on income slab. But, DDT treats all individuals uniformly by taxing them at same rate 20.47%. To expect a person whose income is below exemption limit or comes under 10% slab, pay tax on dividend income at much higher rate is ‘regressive’.
Yashwant Sinha was right when in 2002-03, he restored the dispensation of taxing dividend income in the hands of shareholders. Getting back to DDT in 2007 may have been prompted by convenience and ease of administration and collection [dealing with thousands of companies is obviously much easier than millions of assesses], but it compromised on the basic principle of direct taxation.
In contemporary times when use of IT [information technology] has made it possible to track millions of assesses and their income from various sources [including dividend income], Jaitely could have used the opportunity to revert to what Sinha – also under NDA [then led by Vajpayee] – did over a decade back. Far from that, he has made the system even more convoluted.
In his 2016-17 budget, Jaitely has not only retained DDT [that too at unconscionably high extant rate] but also, brought in tax in the hands of recipients for individuals/HUF. This also results in an abhorrent scenario whereby profit from business is taxed thrice; first, on income of corporate, second, DDT and third, in the hands of recipient!
That the tax rate in the hands of recipient has been kept at 10% [nearly half of DDT rate] is no consolation. No one will even take notice of this when principles are thrown to winds. The government can either tax dividend income at the distribution point or in the hands of the recipients. It would be fallacious to levy at both the points.
The proposal is completely out of sync with Modi-government’s much adumbrated philosophy of offering a “stable”, “predictable” and “investor-friendly” tax regime. Apart from vitiating investment climate, this leads to all sorts of unintended consequences.
For instance, just to beat the new tax, as many as 321 companies [including 5 public sector undertakings] have declared dividend amounting to Rs 45,000 crores during March, 2016. This is an eight-fold jump over the same period last year when 27 companies announced dividend worth Rs 5850 crores. This is not a good omen at a time when increase in investment is the need of the hour to give a boost to economy.
The FM should take a re-look at the proposal. Ideally, the dividend income should be fully exempt from tax. This will provide huge incentive for channelizing household savings in to projects for expansion and growth. At the least, he should withdraw DDT and tax dividend only in the hands of recipient at relevant rates under the Income Tax Act.