In the Union Budget for 2016-17, Finance Minister Arun Jaitely proposed that if the 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% in the hands of the recipient.
This is over and above the dividend distribution tax (DDT) currently paid by firms at 16.99% (inclusive of surcharge and education cess] of the dividend amount so declared, distributed or paid. With the grossing up [as per Finance 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 recipient when P Chidambaram, then finance minister switched over to DDT at 10% which was subsequently increased to 12.5%.
The position was reversed in 2002-03 when Yashwant Sinha, then NDA finance minister, restored tax on dividend income in hands of recipient with increase in threshold limit for exemption from TDS (tax deducted at source) from Rs 1,000 to Rs 2,500. Meanwhile, a committee under former finance secretary Vijay Kelkar was set up to examine the issue de novo.
In 2007-08, based on the recommendations of the Kelkar Committee, the then UPA – government resurrected the 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 the Finance Bill, 2014).
With the proposal in the 2016-17 budget, for the first time ever, we have DDT on distributed profits coexisting with tax on dividend income in 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 as it is known in 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 giving to shareholders is flawed. How can the same income be taxed twice?
All shareholders put together constitute a 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. Yet, the view of the revenue department to treat dividend income as an independent stream is untenable and unjustified.
For a moment, let us grant that a shareholder can be distinguished from a company albeit for purpose of tax. Logically, it should be taxed in hands of recipient instead of taxing at distribution point [read DDT]. Yet, by taking recourse to the latter, the government would be violating a basic tenet of direct taxation.
This principle requires that persons with lower income are taxed at lower rate while those with higher income pay at higher rate. This is the premise for taxing personal income wherein the rates are 10,20 and 30% depending on the income slab. But, DDT treats all of them ‘uniformly’. To expect a person whose income is below exemption limit or comes under 10% slab pay tax on dividend income at much higher rate of 20.47% 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 regime in 2007 might have been prompted by convenience and ease of administration and collection (dealing with thousands of companies is much easier than millions of assesses), but it compromised on the basic principle of direct taxation.
Follow Sinha’s example
In contemporary times when use of 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 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 whose dividend income exceeds Rs 10 lakh. This also results in an abhorrent scenario whereby profit from business is taxed thrice; first, as income of body corporate, second, DDT on distributed profit 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 ever be enthused by this when principles are thrown to winds. The government can either tax dividend income at the distribution point or in the hands of the recipient. It would be fallacious to levy at both the levels. The proposal is completely out of sync with the 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 PSUs] have declared dividend amounting to Rs 45,000 crore during March, 2016. This is an 8-fold jump over the same period last year when 27 companies announced dividend worth Rs 5,850 crore. 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 finance minister should take a re-look at the proposal. Ideally, the dividend income should be exempt from tax. This will provide huge incentive for channelising 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.
(The writer is a policy analyst)
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