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D. Sampathkumar

EVER since the Finance Minister, Mr Yashwant Sinha, proposed the abolition of dividend tax on companies and the re-imposition of tax on dividend receipts by shareholders, a heated debate rages about the merits of both schemes of taxation. Critics of the latest Budget argue that it is a regressive move while its supporters claim that it is a return to sanity in taxation.

It is worth recalling that barely five years ago, the United Front Government at the Centre saw merit in the shifting the tax burden to that of companies paying out dividends to shareholders. In fact, it was then hailed as a wonderful piece of pragmatism in taxation policy. The then Finance Minister was complimented for shifting collections increasingly to the source where income originates rather than wait till it accrues in the hands of recipients as was the case till then — an arrangement that was seen as plugging a source of revenue leakage.

Now the wheel has turned a full circle with the Government bringing back taxation of dividend incomes in the hands of shareholders and simultaneously, a deduction of tax at source, in the hands of companies paying out dividends.

All this makes one wonder if there is something like a correct tax policy. Did the United Front government get it right when, in 1997, it sought to leave shareholders out of tax net but go after the companies paying dividends? Alternatively, should we conclude that Mr Sinha is right in wanting to tax shareholders on their dividend receipts rather than the companies paying out these dividends? Of course, there is a related question. If Mr Sinha is indeed right, why has it taken him four years to rectify that mistake?

Of course, there are no answers. But the basic problem is not with principle of taxation of dividend income but with the structure of taxation itself, in which tax on incomes is merely a component. Today, we have a structure that is four-layered. There is the tax on incomes. Out of the incomes earned, what gets spent suffers a tax by way of excise duty on manufacture or a service tax. What remains unspent adds to the corpus of wealth, which then suffers a levy by way of a tax on wealth. Upon death there is, then, an Estate Duty as well.

The composite structure of taxation is supposed to provide for resources for economic growth and in the near term, poverty alleviation and, of course, an egalitarian society.

The scheme of taxation is essentially income-centric. Even a wealth tax is really a tax on unspent incomes. If all taxes are `income-centric', there is a perception of multiple levies as contributing to a cascading effect of taxation. It is as though incomes are taxed once (income tax), twice (excise/sales tax), thrice (wealth tax) and the final levy is the duty on the estate of a deceased person. To mitigate this cascading effect, minimum exemption limits, concessions for deserving causes, small assessees and so on, are built into the respective tax codes. But concessions can also be exploited by the undeserving. So the drafting of the law has to be extremely rigorous. But that adds to the complexity.

We have four layers of taxation that are supposed to squeeze out the maximum resources without attracting the charge of being oppressive. But we need to ask the more basic question. If there exists a hierarchy of taxation in four layers, do we need all four layers to be subjected to taxation?

Perhaps three layers, starting with taxes on consumption, to tax on wealth and a tax on inheritance could well trap all that there is to mop up by way of taxation. In other words, the tax on incomes may conveniently be omitted without the risk of loss of revenue. There is nothing that a tax on incomes achieves which cannot be achieved by a combination of excise duty (including service tax) and a suitably calibrated wealth tax and estate duty cannot achieve.

A tax on incomes is such an indispensable aspect of revenue mobilisation by the state that any argument for its abolition may seem somewhat outlandish. This is because income-tax has been seen as a far more equitable system of taxation as opposed to indirect levies such as excise duty that are considered somewhat regressive.

The classical argument in the excise duty versus income-tax goes something like this: An excise duty levy does not recognise differences in the capacity of individuals to absorb that levy. For instance, a Tata and a rickshaw-puller would be required to pay the same amount of excise duty on diesel used by them. The iniquitous aspect lies in the former using it to power his Mercedes and the latter his motorised rickshaw. But this is a spurious argument.

The truth is that income-tax too is, more often than not, a `pass-through' with the tax being factored into the cost of goods/services consumed by the large majority of the public. When a company prices its product, it takes into account, the need to earn an after-tax surplus on shareholders funds employed and then works backwards to arrive the unit price of goods produced.

Incidentally, it would also take into account the employee compensation costs which, in turn, factors in the need to leave with employees an after-tax surplus that is consistent with the standard of living that the company expects its employees to have. The price of toothpaste that the man in the street pays takes into account the taxes paid by the MNC making it and it also takes into account the tax-impacted compensation paid to its chief executive.

As a matter of fact, even the Government recognises that the end product price must take into account the income tax component on the capital employed. In the administered pricing regime for fertilisers and, until recently, for petroleum products, the retention price allowed by the government to companies engaged in the manufacture of these commodities took into account the need for these companies to earn a profit of 12 per cent on the capital employed after payment of income-tax on such profits. So the fertiliser consumed by the cotton farmer in Andhra Pradesh or the wheat farmer in Punjab is paying for the tax imposed on the profits of fertiliser companies.

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