GN Bajpai, Sebi's new chairman, has taken the first available opportunity to prove his loyalty to those who appointed him. While doing so, however, it seems to have slipped his mind that Sebi's primary duty lies in protecting the investors' interests, and not in collecting taxes for the Finance Ministry.
It was none of Sebi's business to save the Finance Ministry from the consequences of its ham-handed and entirely unjust plan to bring back the taxation of dividends.
It should therefore have let the stock exchanges decide on allowing a waiver of the required notice periods to allow companies to distribute interim dividends, certainly an investor friendly measure.
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True, some of the bourses would have succumbed to the Finance Ministry's pressure, but that was a matter entirely between the Finance Ministry, the stock exchanges and their respective consciences---Sebi had no business interfering.
Apart from yanking the cash out of the hands of investors----some estimates put the total amount as high as Rs 2250 crore---the incident illustrates that "independent" regulators in this country are merely a proxy for government control.
Having got that off my chest, is the inability to distribute dividends that bad? Shouldn't the amount of undistributed dividend add to a company's reserves, boosting its net worth, its book value per share, and ultimately the value of its stock?
Dividend taxes are, as has been discussed ad nauseam, a form of double taxation. When dividends are taxed in the hands of the receiver, the investor pays personal income taxes on cash dividends distributed to him and, in addition, his portion of the total earnings of the company is subject to the corporate tax rate. Thus, unlike other sources of income, dividend income is taxed twice, under two different income taxes -- personal and corporate.
Viewed in this light, paying dividends may seem to be complete lunacy. There are, however, a few more facts to consider. If a business cannot spend its earnings productively, payment of dividends is unavoidable.
Once the earnings have been booked only two alternatives remain: add them to the company's working capital pool or pay them out. Once the company has amassed working capital adequate for its needs, the shareholders begin to become restive.
They point out that if the company can't think of anything to do with the money other than buy Treasury Bills, why not give it back and let the investor decide what to do with it. The text book case of share prices going up because funds are retained in the company works only if the company can find something worthwhile to do with the money.
Fast-growing companies, that need plenty of money for growth, will fall in this category. Cash cows in mature industries have far fewer opportunities for growth, and would do better to return cash to shareholders.
Now that dividends are taxable, in what form should companies distribute the cash tax-efficiently? The challenge for corporate management is to invent an alternative dividend strategy that retains earnings for corporate use and minimizes the need for debt financing; maintains after-tax shareholder income without reducing corporate cash flow; reduces the amount of taxes paid on shareholder income, and increases the possibility of higher stock-market valuation.
Several alternatives have been suggested, including bonus shares, bonus debentures, and a buy-back of shares. The bonus debenture option is structured so that the investor will have to pay a capital gains tax when the debentures mature.
But recall that HLL had provided for dividend tax, thus giving rise to the suspicion that bonus debentures could be termed deemed dividends. Bonus shares, which can be thought of as the payout of a stock dividend as opposed to a cash dividend, have no dividend element, but suffer from the fact that they lead to a permanent increase in capital.
Bonus debentures, or even bonus preference shares, can be redeemed. Bonus debentures also benefit from the fact that the interest payable on them is tax deductible. But perhaps the buyback is the best possible option for rewarding ordinary shareholders.
A buy-back through the tender of shares route not only enables investors to exit from part of their holdings at a price higher than the market, but it also exerts an upward pressure on the market price, creating value for all shareholders.
The problem with buybacks, however, is that promoters cannot benefit from it, because tendering their own shares for buyback would depress their holdings. As a matter of fact, promoters will be the worst affected by the decision to tax dividends.
The tax-free nature of dividends benefited them because, instead of drawing high salaries taxable at 30 per cent, they could get tax-free dividends. Now that dividend income will be taxed at the same rate as salaries, promoters might as well award themselves hefty salaries.
The benefit for their companies will be that these salaries will be tax-deductible, while dividends were not.Corporates and investors must put their heads together in the noble cause of finding a way to keep the tax collector's grubby fingers out of their hard-earned wealth.