Any such move will not only impact tax collection, but also affect the investment cycle
The corporate tax rate cut announced by Finance Minister Nirmala Sitharaman last September was estimated to cause a revenue loss of Rs 1.45 lakh crore. Data released by the Central Board of Direct Taxes (CBDT) based on tax collection till September 2019 shows that income tax receipts increased a merely 4.7 percent as against 17.5 percent projected in the Budget.
This is a worrying situation because it does not include the impact of tax cuts that were announced after the due date for paying second instalment of advance tax. There is similar trend in indirect tax collection where tax mobilisation slowed due to decline in consumption. The government is struggling to meet its fiscal deficit target amid growth slowdown and cannot expect a substantial tax buoyancy to improve the situation.
The Budget preparation is already under way and people are giving their inputs to the officials concerned. India Inc is demanding abolition of the dividend distribution tax (DDT) on the pretext of double taxation. DDT is paid by a domestic company, which declares dividend.
It is necessary to understand the mechanism of this taxation and rationale behind imposition of DDT before concluding it as double taxation for the taxpayer. According to some estimates, DDT contributes approximately 8 percent of the overall corporate tax collection.
Section 115-O of the Income Tax Act, 1961, which mandates companies to pay DDT, has been amended, with beneficial provisions for assessees. Initially, when DDT was introduced in the Budget of 1997, Section 10(34) [Section 10(33) at that point] was inserted in the Act, which stipulated that dividend received by any person shall be exempted from taxation. In a way, DDT acted as a mechanism to ensure that due taxes are collected at the source stage itself, notwithstanding the tax status of the person receiving such dividend.
Taxability of dividend has changed over time and in the Budget of 2008, the government allowed domestic companies to offset the amount of dividend received from its subsidiaries while computing DDT liability. The Budget in 2016 took away some of the benefits enjoyed by taxpayers and Section 10(34) of the Act was amended and a new section 115BBDA was inserted. From 2016 onwards, dividend income of over Rs 10 lakh is taxable at a rate of 10 percent. A few years ago, the government introduced tax on buyback of securities since companies had started taking the share buyback route to avoid DDT.
It is important to discuss the rationale behind implementation of DDT and its relevance in the current scenario. DDT was introduced with an aim to plough back the profit for investment and expansion. Gross fixed capital formation (GFCF) as percentage of GDP declined to approximately 29 percent in 2017-18, from 34.1 percent in 2011-12. There is a steep decline in gross capital formation (GCF) ratio also.
The private industry has not unveiled any major investment after the recent corporate tax cut and therefore, abolishing DDT at this point may prove to be counterproductive. To a certain extent, DDT restrains companies from distributing the retained surplus by way of taxation at the level of the company itself and undistributed profit is used by the companies for the expansion purpose.
Abolishing DDT will not only impact tax collection, but also affect the investment cycle. Therefore, it makes no economic sense to make any such move in the current scenario.
As far as the argument of double taxation is concerned, it must be appreciated that dividend income in the hands of small taxpayers is exempted from tax. Dividend income over Rs 10 lakh in a year is taxed at a concessional 10 percent. From that perspective, it may be argued that the retained surplus belongs to shareholders of the company and for all practical purposes, DDT is in the nature of tax on shareholder’s income, which is withheld at source by the payer.
The element of double taxation has been taken care of by allowing offset of dividend received from a subsidiary while determining DDT liability of the parent entity. If there is a double taxation in the entire chain, then it is on the person -- other than the company, charitable trust and the like -- who is receiving dividend over Rs 10 lakh in a year. DDT ensures that a shareholder with a large stake in a company does not go untaxed and the monetary threshold covers only those individuals who have large portfolios.
The government has already offered a major relief to corporates by reducing tax rates and now, it is time for the industry to respond positively and revive the investment cycle. Usually, public expenditure goes up in the case of an economic slowdown and therefore, asking for another relief is unjustified, given the fact that the industry is yet to respond positively on the concessions that were handed out a few months ago.Shshank Saurav is a Chartered Accountant. Views are personal.LIVE NOW... Video series on How to Double Your Monthly Income... where Rahul Shah, Ex-Swiss Investment Banker and one of India's leading experts on wealth building, reveals his secret strategies for the first time ever. Register here to watch it for FREE.