AdminTaxation of dividends has given rise to an age-old controversy. The classical system taxes dividends in the hands of shareholders. It was thought that this was unfair. Profits distributed by companies have already been taxed. Why tax it again in the hands of shareholders?
The argument appealed to the Government. And, it introduced Section 10(33) in the Income-Tax Act, 1961 through the Finance Act, 1987, which, with effect from April 1, 1998, completely exempted dividends in the hands of shareholders. Simultaneously, tax rates were brought down to 10 per cent, 20 per cent and 30 per cent. The Budget was called a dream budget.
The Section underwent several rapid changes in 1999, 2000 and 2002. Sub-clause 34 was introduced along with sub-clauses 35 and 36 by the Finance Act, 2003 with effect from April 1, 2004.
The Additional Dividend Distribution Tax was introduced by Section 115(O). In addition to the company tax, the Government sought to tax dividends distributed by companies. This stands at 15 per cent today.
Inequity in the law
The then Finance Minister thought that he would end the debate once and for all by exempting dividends in the hands of shareholders. Alas! The debate has worsened. Instead of double taxation, the Additional Distribution Tax on companies has led to multiple taxation when dividends are received by subsidiaries.
A suggestion was made that profits distributed as dividends should be allowed to be deducted in the computation of corporate profits. After all, interest on borrowed funds is allowed to be deducted. Should owned funds of companies suffer a worse treatment? The Government was not convinced. Budget dream soured.
What about the impact of the tax on distributed dividend? Who bears it? Apparently, the company bears it. After all, the corporate entity represents the entire shareholders. The tax burden is shared by all of them irrespective of their economic status.
But for the dividend distribution tax, small shareholders probably would have received a higher quantum of dividends. Inequity is written into the tax law. The result has been corporate barons have been able to receive huge dividends tax-free. Their assets and incomes multiplied.
The combined wealth of the Ambani brothers stood at Rs 72,600 crore, Premji Rs 62,800 crore and Mittal Rs 29,900 crore in 2005. Between 2004 and 2005, their wealth grew by about 60 per cent. A major reason for this growth in income and wealth should be attributed to the tax-free dividends.
The South African Example
There was nothing original in what the Government did in the matter of taxation of dividends. Even before the ‘dream Budget’ was presented, South Africa had exempted dividends from taxation.
Nearly 10 years after, South Africa is now having a re-think on the subject. In 2008, the South African Government announced the withdrawal of the tax on distributed profits of companies. This is known as Secondary Tax on Companies (STC).
It chose to go back to the classical system of dividend taxation. The 10 per cent tax on corporate profits distributed as dividends is now levied directly on the shareholder who received the dividends. Suitable provisions have been made in the South African Tax law to exempt dividends received by charitable organisations and pension funds.
A similar withdrawal of the additional tax on distributed dividends in India can have an electrifying effect on the stock market. The earlier system of dividend taxation frugally exempted Rs 12,000 in the hands of the individual shareholders when dividends were taxed in their hands. Section 80L was a pittance of a relief.
The classical system
It will be worth the while to go back to the classical system of taxing dividends. Exemption for dividends in the hands of shareholders can be on par with the basic exemption limit of Rs 1,50,000. This will ensure that those in the higher income brackets will pay 30 per cent tax on the large dividends they received. It will also ensure fairness to small shareholders.
South Africa simultaneously ensured that international tax treaties are renegotiated so as to ensure a withholding tax of 10 per cent on dividends received by shareholders in Australia, Cyprus, Ireland, Kuwait, Netherlands, Oman, Seychelles, Sweden and the UK. As per the treaty South Africa has with these countries now, dividend from South African companies will be fully exempt from South African tax. This is set to change. There will be a uniform 10 per cent tax on dividends received by residents and non-residents from South African companies.
What applied to South Africa should apply to Indian conditions also. Indian companies have foreign subsidiaries. These foreign subsidiaries repatriate profits to India. At this stage, dividends repatriated to India from such foreign subsidiaries suffer Indian corporate tax of 34 per cent.
We have no system of giving tax credit for taxes paid abroad in respect of dividends from foreign subsidiary companies. European countries have a system of a participation credit mechanism to exempt dividends from overseas subsidiaries from taxation.
The present system has been in vogue for 10 years. It is time to revisit the way dividends are taxed under the Indian law.
[Source: http://www.thehindubusinessline.com, Author: T.C.A. Ramanujam, former CCIT]
