Simplifying tax on capital

A clear timeline needed for transition to a transparent regime

The government is reportedly considering abolishing the dividend distribution tax (DDT) and making dividend income taxable in the hands of shareholders. The move is expected to boost investor sentiment as it will reduce multiplicity of taxes for companies. DDT is currently levied at a rate of 20.55 per cent, including surcharge and education cess, on dividends paid by companies to shareholders. The government has reasons for reconsidering the DDT. Finance Minister Nirmala Sitharaman had termed the tax a “regressive measure” in the last session of Parliament because it leads to cascading of taxes. It affects foreign investors who are unable to claim credit in their home country since they don’t pay DDT directly. The removal of DDT would also benefit domestic investors who are in a lower tax bracket. Another big reason for reconsidering DDT could be that it was initially imposed to increase the ease of collection. However, most transactions in this category are now done electronically, so it’s no longer difficult for the tax department to track the flow. The removal of the tax was also suggested by the Akhilesh Ranjan panel, which reviewed direct tax laws.

 
The government, however, would do well to take a holistic view of the taxation structure, as frequent changes in the tax system result in instability and increase complications for taxpayers. For example, the government imposed tax on share buybacks in the current financial year to remove the arbitrage between dividends and buybacks. Companies were returning surplus cash to shareholders through buybacks to avoid DDT. But the imposition of tax has significantly reduced buybacks. The bulk of the buybacks that happened in the current fiscal year were announced before the July 2019 Budget. It’s intriguing that the government in July wanted to remove the arbitrage between dividend and buybacks but is now considering abolishing DDT. This reflects incoherence and a lack of objectivity in policymaking. If DDT is removed, companies will start returning surplus cash to shareholders through dividend distribution and avoid buybacks.

 
What is needed at this stage is simplification of the capital gains tax regime. For instance, the definition of long-term varies not only for various asset classes but also for assets in the same category. Long-term for listed shares is one year, but for unlisted share it’s two years. They are also taxed differently. Definition of short-term and long-term is also different for listed and unlisted debentures. Things get more complicated in the case of housing property with several exemptions and restrictions. Clearly, there is an urgent need to bring simplicity and uniformity in the tax structure. It is likely that the direct tax panel would have recommended changes in this area. The government should release the report, as it will enable an informed discussion and help policy-makers make the right intervention. The overhaul of the tax system should be done after proper consultation to avoid recurring changes. A simple and stable tax system, apart from improving compliance, will help both firms and individuals to plan their economic lives better. It is high time that the government avoided further flip-flop and provided a clear timeline for transition to a new transparent regime.