Taxing Dividends

How the budget could address this issue?

As the government prepares for an important budget on February 01st, there are a plethora of expectations from the budget. A very important expectation pertains to how dividends will be treated. We could see some interesting changes in this budget on the dividend taxation front. Here are 3 such key issues pertaining to dividends.

What about tax on dividends?

It may be recollected that a couple of budgets back the government had announced a special tax on dividends above a certain threshold. Dividends have been tax free in the hands of the investors without any upper limit. However, the 2016 budget imposed a tax of 10% on dividends above the limit of Rs.1 million of total equity dividends. Remember that mutual fund dividends continue to be tax-free in the hands of the investor without any upper limit. There have been demands to withdraw this tax as it literally amounts to triple taxation of dividends. That is because dividends are a post-tax appropriation, then they are subject to DDT and finally they are also taxed above Rs.1 million. We do not see dividend tax going away considering that the government wants to make the higher income groups pay a little more to keep taxes for lower income groups lower. On the contrary, we may see multiple levels of tax on dividends coming this year with different thresholds and with varying rates of tax in a progressive fashion.

What about DDT?

In fact, it is very likely that the dividend distribution tax (DDT) could actually be scrapped in this budget. Currently, dividends declared by companies are taxed at 15% and the company is supposed to pay out dividends only after deducting this tax. The problem with the DDT is that it hits all the investors with equal intensity. So, whether an investor holds 100 shares or 1 million shares, the impact of the DDT is almost uniform. The government may look to scrap DDT in this budget as it may be beneficial to smaller investors and will actually give a boost to the equity cult in India. For HNI investors it will also be beneficial as the problem of triple taxation stands reduced to merely double taxation in their case. Essentially, scrapping DDT will hit two birds with one stone.

Taxing buybacks like dividends

This is a very unique concept but the government may experiment with this idea. Currently, large companies who are sitting on huge cash reserves are rewarding shareholders with share buybacks instead of dividends as it is more tax efficient. In such special cases, the government may look to end this arbitrage by taxing buybacks where the shares tendered are above a certain level. Normally, they are tax free due to the capital gains exemption, but the budget may look to make a special case. It could be an interesting decision! ©

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