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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