Cap the benefit

The intellectual argument for exempting dividend payments from tax in the hands of the recipient has rested on the premise that a tax on profits has already been paid by the company in question; and since the dividend paid out by that company to its shareholders is nothing more than the distribution of post-tax money, such distribution should not be taxed again in the hands of the recipient. There are economists who have always disagreed with that argument, on the premise that the individual receiving the payment is different from the company that earned the profits, and therefore a transfer from one to the other should be taxed all over again. This newspaper had agreed with the first line of logic when the finance minister exempted dividends from taxation a few years ago, and supported the move.

However, if most of the benefit from this arrangement goes to wealthy promoters of companies (as we reported last week), there is an implicit equity argument that kicks in. What kind of tax system delivers hundreds of crores of income to the wealthiest people in the country, and asks them to pay no tax on the money they receive""while anyone who earns Rs 30,000 a month pays 30 per cent tax at the margin? The sums involved in the question are large: 1,050 companies have paid out Rs 14,000 crore as dividends over three years, and the tax foregone on this is about Rs 3,000 crore (after reckoning that companies have paid the dividend distribution tax). Half that sum has benefited just 16 families""Azim Premji, the Ambani brothers, Shiv Nadar and others like them. By way of a reference point, the finance ministry has spent more than a year trying to find ways to remove the income tax exemptions on post office savings and other such instruments, to move from a system that exempts such savings from tax completely, to a system that taxes the savings when they are encashed. According to the ministry, such tax sops (for millions of families) add up to Rs 6,500 crore. In this context, it should be obvious that the removal of the tax on dividend was not intended to give someone like Mukesh Ambani a tax-free dividend income of Rs 1,482 crore. The lack of equity is too blatant to bring any kind of taxation theory into the picture.

One of the intentions of granting the tax exemption was to give an added incentive to people to invest in the stock market, and the moral justification was that investments in post office deposits and banks got similar tax exemptions, up to a limit of course. So, if these tax breaks were not offered to equity investors, the playing field would not be level. The tax breaks, then, were essentially meant for the small investor, and this end-purpose is precisely what the finance ministry should now restore. That is, dividend income should be free from taxation in the hands of investors only up to a certain limit, say a cash limit of Rs 1 lakh. It cannot be the case that if dividend incomes above that level are taxed, promoters of companies will dilute their equity stake and deposit the money at the nearest post office.

The figures suggest that small investors hold a relatively small proportion of the total equity in companies, certainly less than 10 per cent. Foreign institutional investors in any case enjoy a tax-free regime. So the principal target of such a change in the dividend tax will be the wealthiest people in the country""and even they are not likely to argue that the change is unfair or illogical.