DDT dissuades corporates from distributing a dividend to shareholders, preferring to hoard their profits, even if they have no good use for such cash surpluses.
India has been facing a slowdown in its growth rate, consistently for the past eight quarters, but the government is in a denial mode, was late in recognizing the crisis and has thus been late in initiating measures to revive the slowing economy. The government never did realize the gravity of the crisis at its very inception and it thus primarily relied on monetary policy initiatives, to revive the economy. The RBI has been pruning the interest rates, month after month, making money cheaper and hoping that it will encourage corporates to borrow and invest and that consumers will borrow to spend, thus reviving demand.
The multiple rate cuts affected so far this year, have done little to revive India’s struggling economy. Ironically, despite money becoming cheap, there are few takers for bank loans, with the growth in fresh bank credit falling to a three year low. But monetary policy initiatives are not enough, particularly where the slowdown is chronic and the causes are structural. With these monetary policy measures by way of interest rate cuts giving little results, the government has now been resorting to fiscal measures, by pumping money into the economy, hoping that it will help to stimulate investment and consumer demand.
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Fiscal initiatives include putting money it no the hands of corporates and consumers, whether directly or indirectly and these so far have included the loans melas, recapitalizing banks and NBFCs, ramping up expenditure by government departments, and most important cutting corporate tax rates, which would result in a tax saving of Rs.1.45 lac crores for corporates and to that extent will put money directly in the hands of corporates, hoping that corporates will either invest these tax savings into new projects, or will bring down the prices of their goods, so as to stimulate consumer demand. But contrary to the government’s expectations, at a time of the present economic slowdown and receding corporate sales/profits, they are not routing these gigantic tax savings into fresh investments.
A recent survey says that over 80% of corporates do not wish to invest these huge tax benefits into new projects, preferring to use it instead to retire/repay debt, build up cash balances to strengthen their finances, to distribute dividend and to buy back shares. Stressed corporates are unlikely to make fresh investments in a slowing economy and falling consumer demand and will prefer to strengthen their finances instead, with the surplus arising out of these tax rate cuts.
With these fiscal and monetary initiatives of the government, taking their own time to enthuse investors and to revive the moribund economy, the latest news is that the government is considering a proposal to scrap dividend distribution tax (DDT) and rationalize the structure of levy of long term capital gains. DDT is an obnoxious and unfair tax that was introduced by the government in 1997. Apart from paying taxes on corporate profits, companies also pay an additional tax of about 20% by way of DDT, on the profit that they wish to distribute as dividends to shareholders.
It is certainly a double tax on the same profits in the hands of the company. Upon payment of DDT, the dividend received by the shareholders is exempt up to Rs.10 lakh and is taxable thereafter at 10%, resulting in a triple levy of tax on the same income. This DDT dissuades corporates from distributing a dividend to shareholders, preferring to hoard their profits, even if they have no good use for such cash surpluses. The removal of DDT was also recommended by the latest Direct Tax Task Force that was set up by the government to formulate a new tax code. The mere rumours of DDT scrapping have boosted the share markets, such that the Sensex has crossed the 40000 marks and continues to rise.
The government collects over Rs.55000 crores per year by way of DDT. But scrapping it would not mean that much of a loss to the exchequer. If the DDT is removed, it is the recipients of dividends that will pay tax on it and the loss of revenue is not expected to be significant. And if it is removed, the impact on market and investor sentiment will be significant and could see investors rushing back to the Indian bourses, as also FDI flowing in, to take advantage of pruned tax rates and no DDT on the distribution of profits. Even though the budget is now a mere three months away, a desperate government can scrap the DDT, as a booster steroid to the stock markets and to the slowing economy.
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