Successive Finance Ministers have realised that measured spraying of DDT Dividend Distribution Tax in Budgets is like providing a huge tax net over an entire corporate sector.

D. Murali

When the Finance Minister applied the DDT spray with added potency, in Budget 2008, corporates winced at the fresh bite. DDT that we are worried about is not `Dichloro-Diphenyl-Trichloroethane', the first modern pesticide `developed early in World War II, and initially used with great effect to combat mosquitoes spreading malaria, typhus, and other insect-borne human diseases among both military and civilian populations, and as an agricultural insecticide,' as



The DDT spill in the Finance Bill is about Dividend Distribution Tax that threatens to bite and chew off nearly 17 per cent of payouts.

Debuts in 1997

The tax is not new. It made its appearance in 1997, when Mr P. Chidambaram imposed a 10 per cent distribution tax on companies, while at the same time exempting dividends in the hands of recipients.

On February 29, 2000, Mr Yashwant Sinha doubled the rate to 20 per cent. Paragraph 159 of his Budget Speech read thus: "At present, no tax is payable in the hands of shareholders on the dividend income received from a domestic company, only the company pays additional income-tax at the rate of 10 per cent on the amount of dividends distributed by them. The large gap in the tax treatment of dividend income and interest income has been widely criticised. To reduce this anomaly, I propose to increase the rate of tax on dividends distributed by domestic companies from 10 per cent to 20 per cent. I would clarify that dividend income in the hands of share holders will continue to remain tax-free."

However, in his subsequent Budget, Mr Sinha reverted to 10 per cent, `to provide a stimulus to the growth of capital market.'

In 2002, he devoted a long paragraph to the topic: "Under the present system of taxation of dividends and income from units, the company or the mutual fund pays a 10 per cent tax, and the income is exempt in the hands of the recipient. Such a system not only taxes income in the hands of a person to whom it does not belong; it also militates against the pass-through status which is the very essence of a mutual fund."

"There is also an inherent inequity in the present system, which allows persons in the high-income groups to be taxed at much lower rates than the rates applicable to them. These issues have been troubling me over the past four years, and I am now convinced that the existing system must go."

Therefore, distribution tax of 10 per cent got the axe. Dividend income `will henceforth be taxed in the hands of the recipients at the rates applicable to them, and will be subject to tax deduction at source at the rate of 10 per cent,' said the Finance Minister then.

Receivers freed, givers hurt

When presenting his `sixth successive Budget', on February 28, 2003, Mr Sinha vowed to bring the small investors `back to the equity markets by restoring their confidence'. Towards that end, possibly, was the dividend distribution tax paragraph numbered 89 in the Budget Speech of 2002. It read thus: "From April 1, 2003, it is proposed that dividends be tax free in the hands of the shareholders. Correspondingly, there will be a 12.5 per cent dividend distribution tax on domestic companies."

In 2004, it was Mr Chidambaram's speech that we heard on the B-day. He hiked the DDT rate to 20 per cent for corporate unit holders in debt-oriented mutual funds. "I am sure corporates will understand, because I am doing no more than partially closing a window of arbitrage opportunity," he reasoned. In 2005, his speech ran to nearly 14,000 words, but the FM stayed away from the word `dividend'.

Last year, Paragraph 164 of the Budget Speech proposed an alignment of the definition of open-ended equity-oriented schemes of mutual funds in the Income-Tax Act with the definition adopted by the Securities and Exchange Board of India. "I also propose to treat open-ended equity-oriented schemes and close-ended equity-oriented schemes on par for the purpose of exemption from dividend distribution tax," said Mr Chidambaram.

In this year's Budget, Mr Chidambaram spoke of how `we can take advantage of the demographic dividend', but that didn't stir the corporates. About 70 paragraphs later, the Minister came to DDT, after dealing with `works of art'. Paragraph 176 read: "I believe that my direct tax proposals have brought about more horizontal equity. It is also necessary to improve vertical equity. Having regard to the capacity to pay, I propose to raise the rate of Dividend Distribution Tax from 12.5 per cent to 15 per cent on dividends distributed by companies." Taking into account surcharge and education cess, effective rate of DDT will be close to 17 per cent, at 16.995 per cent.

Indoor spraying of DDT, the pesticide, is `like providing a huge mosquito net over an entire household for around-the-clock protection,' says a snatch on

. Similarly, successive Finance Ministers have realised that measured spraying of DDT in Budgets is like providing a huge tax net over an entire corporate sector.

(This article was published in the Business Line print edition dated March 9, 2007)
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