The Hindu Business Line : Added DDT burden

The Finance Minister believes that his direct tax proposals have brought about more horizontal equity. And to improve vertical equity, he has thought it fit to raise the dividend distribution tax (DDT) rate from 12.5 per cent to 15 per cent on dividends distributed by the companies. He also feels that to remove distortions, the DDT should be raised to 25 per cent for all investors in money market mutual funds and liquid mutual funds.

As proposed under the new Section 115R of the Income-Tax Act, 1961, the tax rates for income distributed by mutual funds are as follows:

Money market mutual fund or liquid fund, 25 per cent.

Any fund other than the above, if the distribution is to an individual or the HUF, 12.5 per cent.

A fund (other than a money market mutual fund or liquid fund) to any other person, 20 per cent.

These terms, `Money Market Mutual Fund' and `Liquid Fund' will have the same definition as given in the Security and Exchange Board of India (Mutual Fund) Regulations 1996. The hike in the tax rate in the case of money market mutual fund will definitely benefit banks. These funds were offering a much higher return on investment for both individuals and companies than bank deposits.

PHENOMENAL GROWTH

In the past one year, there has been a phenomenal 81 per cent growth in the outstandings of money market mutual funds. The amendment to Section 80CC last year, making bank deposits eligible for tax deduction up to Rs 1 lakh, did not help much because of the long lock-in period of five years. The current amendment will reverse the process. Money market mutual funds will become less attractive. The fund managers will not be able to distribute as much dividend as they were doing hitherto.

There is, however, no equity involved in raising the DDT rate for companies from 12.5 per cent to 15 per cent.

It was Finance Act, 1997 that altered the scheme for taxing dividends. Section 10(33) was brought in, which exempt dividends in the hands of shareholders. Section 115(O) was introduced in Chapter XII D, and this levied a tax of 10 per cent on distributed profits on companies.

There was an endless debate at that time on the question of double taxation of dividends, first in the hands of the company when corporate tax is levied on profits and then in the hands of the shareholders when the same profits are distributed as dividends.

The Finance Minster declared at that time that he proposed to end the debate by exempting dividend from taxation in the hands of shareholders.

DOUBLE TAXATION

The truth is, despite semantics, even the new levy results in double taxation. Whereas formerly the shareholder was taxed, now the company itself is baring the burden. There can be several ways of dealing with the problem.

Cost of capital should be allowed as a deduction, whether it is termed as interest or dividend. The Chelliah Committee did not recommend the shift in the method of taxing dividends. The US and the UK have not shifted to this method of taxing dividends in the hands of the companies.

The law does not provide for saving in respect of dividends received by holding companies from subsidiaries or vice versa. It is well known that infrastructure companies normally set up a special purpose vehicle (SPV) to finance the projects and this results in a two-tire structure.

Such companies will have to pay dividend tax twice from the same venture. The tax impact is not just 15 per cent, it can go up to 16.99 per cent if surcharge and cess are taken into account.

According to one quick estimate, a survey of 1300 dividend-paying companies showed that the additional tax burden would be Rs 1,750 crore.

INEQUITY

There is no equity involved in the dividend distribution tax itself. Under the old system, dividends were exempt up to Rs 12,000 under Section 80L of the Act in the hands of individual shareholders. Under the new dispensation, promoter shareholders getting huge dividends will be let off.

The burden on the company is passed on to all shareholders and the small shareholders will certainly lose in terms of the quantum of dividend received. Probably it will be better to revert to the old system, as there was some equity involved . The interests of small shareholders were taken care of.

The big fish will have to pay tax at the maximum marginal rate when dividend is taxed in the individual hands. There will be better corporate democracy. The present system benefits only big corporate houses and their promoters. At any rate, the hike in the DDT should be withdrawn.

(The author is a former Chief Commissioner of Income-Tax.)

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