Thursday, July 10, 2014

UNION BUDGET 2014 - TAXING DIVIDENDS - SHOULD NOT BE IN SHAREHOLDERS' HANDS



TAXING
EQUITY DIVIDENDS

Should Tax on dividends be paid by companies, or, by Equity Share Holders? 

This confusion often arises in India in the minds of the Governments. 

But, this question really has two Parts. 

(1)   Is there is a real and clear Justification for taxing Equity Dividends at all?
(2)  If so, at whose Hands are the Dividends to be taxed?

I shall examine the two issues in two parts.

Part.1 : Is there Justification for Taxing Equity Dividend?

I am not talking here about preference dividends, interest on Debentures and interest payments on other methods of financing companies. These people are creditors of the company and the debtors happen to be the company, which, really and factually, means the Equity share holders.

If the company goes bankrupt, all these ‘creditors’ get paid whatever is possible out of the Sale Proceeds of the company and the payment actually comes from the money of the Equity share holders, for they only take the risk in being the OWNERS OF THE Company.

If debt holders don’t exist, like in some debt free companies, the equity holder owns everything. There is no case where a company consists of only debt instrument holders with no Equity Owners.

Look at a few risks the Equity holder takes:

(1)         He buys the equity initially in public issues or in secondary Market. He buys it at Market rate. But, the market price often goes down from Rs.400 to Rs.40 in a year’s time. We all know that it has happened many times in Indian market, and will continue to happen in future. This is really the “Owner’s” risk in owning the company. No one sympathizes with him when his company’s fortunes go down and the share price goes down. Many Equity share holders lose a lot of money in the market almost EVERYDAY in the market. But all debt holders do get paid almost always.

(2)         Some companies go bankrupt. It is the Equity share holder who suffers most in such case. If company has gone down, he has gone down. For every one company which does well, ten companies disappear into the oblivion and it is always the Equity share holder who loses his shirt.

(3)         For all practical purposes, Equity shareholder is THE COMPANY. The company functions as an artificial Juridical person only because of size and convenience and not because, the equity share holder is any way saved from any risk associated with ownership.

(4)         Ad company, all equity shareholders are taxed already in the their (company’s) P&L Account where profit before tax is computed, taxed and then profit after tax is computed. The PROFIT BEFORE TAX is the real, taxable income of the equity shareholders; they are paying the tax on that profit and the rest is their real income after tax – and we call it PROFIT AFTER TAX. So, when they take a part of it home as dividend, why tax it again? In my view, there is no justification for taxing the equity shareholder’s income twice, once in the P&L account and then again beyond it, as Tax on Dividend.

(5)         Many companies in the west do not pay any dividends at all! This also does not make any sense. And, it is not Healthy at all for the equity investment culture. The company’s Balance sheet becomes fatter and fatter. But, what does the owner, the Equity Shareholder, eat? Doesn’t he need to take home some money for his personal living expenses?

(6)         Consider a sole proprietor Business. He also employs people, does business and earns income. He also pays tax on his ‘profits before tax’. But, when he takes a part of the ‘profit after tax’ home for his monthly expenses, do we tax him again on the money so taken by him for his household expenses? We don’t. We should not. That becomes expenditure tax, apart from the income tax already paid by the business man.

(7)         Dividend is the amount taken away from the company for the personal, household expenditure of the Equity owner. It is very much so. Unless, this is treated so, the equity culture in India will not improve at all. This is one of the main un-understood reasons, why retails investors often shy off from Equity Markets in India and prefer debt instruments.

(8)         Dividend is the income set apart for the equity owner’s household expenses and his total income is already charged for Tax in the P&L Account. Where then is the Justification for taxing dividends?

(9)         Let me draw one more parallel. Suppose Rahul Bajaj buys out all shares and become 100% owner of Bajaj Auto. When Bajaj Auto pays tax on the profit before tax, it is actually Rahul Bajaj who is paying this tax on his own Income. There is no company apart from him. Suppose Bajaj Auto fails to remit this tax, it is Rahul Bajaj, who will be penalized by the Law in so many ways. Now, he pays the tax in the name of Bajaj Auto once. If he doesn’t take out anything as Dividend (and assuming he has no other income), how can he meet his living expenses? Suppose he withdraws money for this purpose from company, it is called dividend, and treated as his separate personal income and taxed again! If he is not Rahul Bajaj owning a company but is Some XYZ owning a Bug retail shop, the same money taken out by him is not treated as dividend and not taxed again!

(10)      Do we understand the hardship being already meted out to the Equity share Holder? He is Owner for all losses of the company. He is the owner if company goes into liquidation. He is owner liable for all tax payments of the company. He is owner to pay second time tax on whatever dividend he gets, even after full tax payment by the company. I feel, this is plain injustice. Ideally, Dividend should not be taxed and companies must be encouraged to pay more dividends and encourage Equity culture, in a country like India which is so poor in the Equity Investment culture.

Part.2 : In whose Hands should Dividend be taxed? Company, or, shareholder? 

(11)      Now, the position in India is, dividend is being taxed separately, as income of the receiver, thus discouraging the equity culture already. Even if this is to be so, in whose hands should it be taxed? Company, or, Shareholder? 

(12)      The system of Tax deduction at source is the simplest, easiest and most hassle free. So far, this system was followed. In this budget, Hon’ble Minister, Arun Jaitleyji, for some reason, has transferred the onus to the shareholder who receives it. I very earnestly request Jaitleyji to reconsider this, on the basis of the following justification.

(13)      By virtue of this proposal, the Government will now have to be waiting for the receipt of this Tax on Dividend till the year is over. If company had deducted it, it would have paid it instantly. But, in the hands of the millions of the shareholders, how to does Government ensure its receipt and when? It will have to wait for the year end in most cases.

(14)      Many of these millions of Equity shareholders may not be in tax bracket at all. They need not pay any tax on dividends! 

(15)      Now, Government wants to open up PSU shares to millions of retail shareholders. The hassle is, some will receive 20 Rupees dividend and have to pay 2 Rupees tax on it, keeping account of the dividends they receive. Do we expect all intermediaries in the stock market to be providing full and clear Info to all these millions of shareholders and further expect the Post office/couriers to be delivering all the warrants perfectly to all shareholders? That is not the case in India. Stock market has improved a lot but there are hassles still – from the stage of the company sending dividends,  to the couriers delivering the same; to banks actually collecting and depositing the same.

(16)      This is therefore clearly an avoidable hassle. Why trouble millions of shareholders, when company can pay it at one go from the source of dividend, without trouble immediately? Shareholders may be in different tax brackets or no bracket. If all of them are taxed at a single lowest rate and the money is paid at once by the company , what is the harm?

(17)      Probably, the Government is looking only at top shareholders like TATAs, Birlas, Ambanis etc and expecting them to pay tax on dividends at higher rates. But, it is forgetting the enormous hassles it is subjecting the millions of retail investors to in this process – which is definitely not worth the trouble.

(18)      As a middle path, the Government can still work out a formula like this : (i) all those getting Equity dividend of Over Rs.50,000 shall pay the tax on dividend at their end, at their higher rate. (ii) For the Rest of the millions of equity holders, the company shall deduct tax at source, at a fixed rate and pay the balance as dividends to them. This method is easy to monitor by the company, by the Government and by tax authorities. It is received instantly by the Government. It also avoids all unnecessary hassles to millions of small, retail equity holders and enables better promotion of Equity culture in India. Tax Deduction at Source is the best method and most hassle-free.

(19)      Preference share holders, Debenture holders and all other types of Debt instrument holders can never be treated similarly with equity shareholders. Equity shareholders do deserve a hassle-free tax environment, because, their investment is MOST AT RISK.

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