Nullifying a tax proposal

By S. Swaminathan

The Finance Bill 2000 is, technically speaking, a mere embryonic package of tax proposals with Parliament yet to put its seal of approval on it. All the same, one of the proposals contained in it with reference to distributed profits of domestic companies looks almost as if it has been sabotaged even before entering the statute book.

This is the proposal made by Mr. Yashwant Sinha in the budget for raising the tax on dividends ``declared, distributed or paid'' by a domestic company, from 10 to 20 per cent, intended to come into effect from June 1.

Rationale for impost

The presumption that the proposal to raise the tax rate on dividends distributed by a company is driven by the perceived need to curb the recent tendency of Indian corporates to raise dividend rates to unprecedented high levels in order to boost the market value of their shares appears ill-conceived. The approach, on the contrary, seems to be one of maintaining reasonably credible levels of yields on equity, given the fact that share prices have been on the ascendant over the last two years. A high dividend rate, according to this approach, is to an extent a compensation for the high prices at which investors have had to acquire the shares from the secondary market.

Mr. Sinha himself did not seek to relate the move to jack up the tax rate on dividends to any policy which aims at the stimulation of corporate savings for facilitating new investments. He brought in a rather queer logic in support of his proposal. As he put it, ``The large gap in the tax treatment of dividend income and interest income has been widely criticised.'' And so, it would appear, the new tax proposal (20 per cent tax on dividends instead of 10 per cent) is intended to narrow the difference between the tax treatment of interest paid on debt instruments and dividends declared on equity investments. That the whole approach smacks of an unwarranted prejudice against equity shareholders goes without saying. It would perhaps have been far more credible if the Finance Minister had admitted to fiscal compulsions leading to the rather bizarre step of raising the tax rate on dividends.

Sec. 115-O as it stands

The proposal in the Finance Bill relates to Sec. 115-O of the Income-tax Act. This section along with others relating to tax on distributed profits of domestic companies, was inserted in the Act by the Finance Act, 1997, consequent on the decision announced by the then Finance Minister, Mr. P. Chidambaram, to move away from the practice of taxing dividends at the hands of shareholders and instead levying the tax on the company distributing the dividends. Sec. 115-O provides that in addition to the income-tax chargeable in respect of the total income of a domestic company (or notwithstanding the fact that no income-tax is payable by a domestic company on its total income), a tax at the rate of 10 per cent will be payable on dividends declared by a domestic company (whether interim or otherwise) and whether out of current or accumulated profits.

All that the Finance Bill, 2000 proposes is that the rate of tax under this section be raised from 10 to 20 per cent, with effect from June 1. Of course, the proposal would amount to an unfair discrimination against domestic companies as contrasted with foreign companies operating in India.

The mania for interim dividends

Corporates have naturally found the new tax proposal with regard to dividends reprehensible. When the proposal becomes law, companies will have to shell out Rs. 20 to the Government for every Rs. 100 of dividend pay-out.

It can be argued that this will pose additional cash-flow problems for the companies apart from penalising them for participating with the shareholders in the matter of financial benefits arising from efficient stewardship of the companies. That this is an anomaly in an economy where equity investments need to be spurred need hardly be dilated.

But then, what has been the behavioural response of the mainstream corporates to the tax proposal? Just beat the deadline proposed in the Finance Bill - June 1, 2000 - and come up with a spate of sumptuous interim dividend announcements (with expeditious payments as well) so that, in a manner of speaking, you eat the cake and keep it too, or save on taxes while not stinting on dividends!

In other words, the intention behind the Finance Bill in so far as it relates to corporate dividend tax, stands frustrated or defeated even before the tax proposal is translated into a mandate. Strictly honourable in terms of the legitimate interests of shareholders but wholly unethical, even imprudent from the standpoint of the corporates themselves!

How will the Govt. respond?

Suppose that the Finance Ministry is intent on retrieving the revenue lost through so many companies rushing to the interim dividend route after the budget date (February 29). Leave aside the question whether the Government should just wink at the frontal assault already committed on its fiscal proposal. Can the Government now move an amendment to the Finance Bill, advancing the date of the new tax rate coming into force, to say, March 1, 2000? That is in a sense, with retroctive effect?

A fair game in retaliation to what the corporates have indulged in? At a different level, should the whole concept of interim dividend (being declared by the board of directors) be banned?

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Section  : Business
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