Freedom to distribute

Of the various ideas being suggested to the Centre to make equity investing more attractive in the Budget, the one proposing the scrapping of Dividend Distribution Tax (DDT) is among the most sensible. The levy, introduced way back in 1997 to discourage companies from paying out ‘exorbitant dividends’ and to ‘retain their profits for future growth’, is retrograde on many counts.

To start with, it encourages cash-rich companies to hoard their surpluses and deploy them in low-yielding treasury operations, which weigh on shareholder returns. The notion that all companies across sectors and business cycles are better off ploughing their cash back into expansion projects rather than distributing it, is flawed. Taking stock of the cash balances of the top 500 listed companies, about 70 per cent of the total cash is held by just 30 companies from the software, consumer, automobile and commodity sectors. The software and consumer sectors aren’t capital-intensive; firms generate sufficient free cash flows every year to comfortably fund growth. As for the automobile and commodity companies, they may like to time their expansion projects to upturns in the business cycle. All these firms can easily afford to pay out higher dividends to their shareholders without materially affecting their prospects. The resulting improvement in dividend yields will help make Indian equities more attractive to investors. The BSE Sensex’s dividend yield of 1.4 per cent is among the lowest in the world, with markets in China, Thailand, Taiwan and Singapore, and Europe offering nearly twice as much. Returning excess cash to investors instead of letting it idle on corporate balance sheets may also help in the re-allocation of capital to those companies that urgently need it. There are highly leveraged players in the infrastructure, power and steel sectors which continue to borrow at sky-high interest rates. If investors receive higher dividend income, they may choose to re-invest it in high-yielding bonds or other instruments that channel the capital into these sectors.

Finally, DDT in its present form is also inequitable. It represents a form of double taxation because dividends are distributed out of already-taxed corporate profits. As DDT levies a 20.5 per cent tax on all investors, it also subjects investors in the lower tax brackets or those with exempt income to unduly high tax incidence. The Centre should consider doing away with the DDT in toto and making dividends taxable in the investor’s hands, just like any other income. It can also consider exempting annual dividend income up to a certain limit from taxes. This would not only make equity investing sweeter for small investors; it would also help in redistributing capital to more deserving sectors of the economy.