The Hindu Business Line : Kelkar's tax proposals — What's in it for shareholders?

IF you are a shareholder in any company that has paid taxes at more than 30 per cent of its book profits, there is much to cheer in the recommendations of the Kelkar Task Force on Direct Taxes. But if you are a shareholder in a company that falls below this threshold — mostly which have benefited from the incentives and higher tax depreciation rate — then brace yourself for a dent in profits. Assuming the Kelkar proposals are implemented, what do they hold for India Inc and its shareholders?

Dividend tax

The dividend tax, payable by shareholders, or by companies as was the case in the last three years, will go. This will make dividend flows tax free and attractive for shareholders. But will dividend payments increase if this proposal goes? Here one cannot be too sure since high dividend paying companies have continued a similar policy regardless of the tax regime for dividends. One only sees a spurt in dividend announcements in a year when policy changes are made. Investing in steady dividend paying companies trading at a low price, and offering attractive dividend yield may become pronounced. But in the process prices may be bid up and yields will quickly fall.

Long-term capital gains

tax goes

Perhaps the measure that would be awaited with eagerness is the abolition of long-term capital gains tax on equity. Long-term capital gains are now taxed at 10 per cent. If this goes, investors may find more gains in their hands especially from long-term shareholdings. The effect may be more pronounced if stock prices move up from the present sluggish levels. This move may also have an impact in terms of lowering the expected return on equity by investors. Such a development could push up stock valuations by a few notches as a one-time development.

The hard measures

The Kelkar panel has proposed that tax rates should be cut five percentage points to 30 per cent for Indian companies and 35 per cent for foreign companies. But the various incentives will also go. Most importantly, the higher rates of depreciation would go. What depreciation companies report to shareholders is what they can show to the taxman too. This will mean a higher tax outgo especially for companies which have, or are implementing, projects of sizeable capital outlays.

The committee has also suggested that all companies pay a tax of at least 30 per cent of book profits reported to shareholders. To this end, the Minimum Alternate Tax of 10 per cent of book profits would go and companies falling in this category pay a 30 per cent tax.

The likely beneficiaries

For companies that are already paying 30 per cent or more of their book profits as tax, there could be a reduction in the tax outgo.

But this may to some extent be neutralised by the removal of incentives which they may be using to lower their tax outgo now (despite paying more than 30 per cent of profits as tax). A study of 3,000 companies for 2001-02 shows that benefit on this score may be around Rs 3,720 for 612 companies. A bulk of it — 72 per cent — would go to 25 companies. Oil companies such as ONGC, Indian Oil, BPCL, HPCL; banks, Indian as well as foreign, and the likes of Hero Honda and ITC may be the major beneficiaries.

Their valuations may not, however, look up much as all companies would move to a similar tax payout scale (minimum of 30 per cent of book profits).

Higher tax burden

For close to 2,000 companies which pay less than 30 per cent of profits as tax, the additional outgo is likely to be around Rs 8,300 crore as the tax rates applicable to them will move to the prescribed threshold of 30 per cent.

This cannot but have a one-time impact on stock valuation as shareholder earnings get adjusted to lower levels. The likes of Reliance, Hindustan Lever fall in this category. This may not be such a bad thing from a larger perspective.

Better credibility

The credibility of reported earnings and cash flows may improve in the process and this could have a positive spin-off on valuation levels. This cannot be quantified now, but the increase in the comfort level of investors in reported earnings may be a desirable way to go.

Also, companies may refrain from undertaking capital-intensive projects for the sake of tax planning. As shareholders, one can hope that funds would be spent more wisely but in many cases it may remain just a hope.

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