Thursday, January 17, 2008

Should dividend remain exempt from income tax?

Should dividend remain exempt from income tax?

16 Jan, 2008, 0002 hrs IST,

By TN Pandey

The industry and high-income taxpayers abhor a tax on dividends. They say it would amount to double taxation. The argument is that it is wrong to tax the same income twice, once when it is earned by companies and then in the hands of the shareholders as dividends.

In this argument, however, it is conveniently forgotten that the company and its shareholders are two different legal entities. This position has been undisputedly accepted by courts in India and abroad and by jurists such as Lord Halsbury.

In India, the separate legal entities of the company and the shareholders have been accepted by the Supreme Court, which said in this context that “the company is a juristic person and is distinct from the shareholders. There is nothing in the Indian law to warrant the assumption that a shareholder who buys shares, buys any interest in the property of the company, which is a juristic person, entirely different from the shareholders.”

Yet, the lobbying by the industry and high income taxpayers succeeded and dividend income was made tax-free by the Finance Act, 1997, without giving any justification for doing so. The finance minister merely said, while exempting dividends from tax, that an area of vigorous debate over many years relates to the issue of tax on dividends and he wished to end this debate. Hence, he proposed to abolish tax on dividends in the hands of the shareholders.

Obviously, the undisclosed reason was to end the so-called debate regarding double-taxation. But then why did the FM feel shy in admitting this position is a mystery?

More rigorous double taxation introduced

However, by the same act, a worst form of double taxation, was introduced through the dividend distribution tax (DDT), which is presently imposed at the rate of 15% (w.e.f. 01.04.07) on the dividends distributed. Earlier, the tax on distributed dividends and on corporate incomes was paid by two different entities, but now the tax on distributed dividend is paid by the same assessee, the company, firstly when the income is earned by way of corporation tax and again, when out of such taxed income, dividend is distributed, which is subjected to DDT. Thus, double taxation in the existing system is more blatant.

The inequity of the system of taxation in the case of the companies and exempting shareholders from dividend income as introduced by the Finance Act of 1997 was accepted by the then FM, Yashwant Sinha, while presenting the Finance Bill for 2002-03.

Mentioning about this system of taxation, he had said in his budget speech, “There is also an inherent inequity in the present system, which allows persons in high-income groups to be taxed at much lower rates than the rates applicable to them. These issues have been troubling me over the past four years and I am now convinced that the existing system must go. Such income (meaning the dividend income) will henceforth be taxed in the hands of the recipients at the rates applicable to them.”

Thus, the old system of taxing company and shareholders (for dividends) incomes was restored. But the change remained operative for one year only. Sinha’s successor, Mr Jaswant Singh, next year reverted back to the old system without assigning any reasons.

The present system of taxation of companies with the DDT is prima-facie regressive, as it taxes earned income, like wages, salary, pensions, income from business/professions, etc, rather rigorously and exempts unearned incomes like dividends without any limits.

The present position is that the number of persons are becoming rich and super-rich and getting proclaimed as the richest persons in the country and in the world without contributing, according to the canon of ‘ability to pay,’ to the tax kitty of the country. The present system only helps the persons to grow richer year after year as the shares and securities, yielding dividends are also exempt from wealth tax. Such inequitous system needs to go.

The finance minister could take the following measures:

Complete exemption for dividend income should be given to the persons with income (including dividend income) in the tax bracket carrying a tax rate upto 20%.

Full taxation of dividend income may be provided in cases of persons, without income (including dividend income), who fall in the tax bracket carrying tax rate exceeding 20%.

Simultaneously, DDT should be withdrawn.

(The author is former CBDT chairman)

Courtesy_

THE ECONOMIC TIMES

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