Taxes should not be taxing

Published: July 25, 2019 1:05:51 AM

(Ir)rationale of tax on buyback and dividend distribution

tax, income tax, dividend distribution tax, total direct tax collection, tax paid profit, indirect tax on goods, China-US trade tensionsFirst, the operating cost is met, which involves remuneration to employees, payment to third-party vendors for purchase of goods and services, and indirect tax on goods or services sold.

By Jagvir Singh

There are two ways of return of money to shareholders by a company as a going concern—dividend and buyback—and both use tax paid profits of a company. So, it’s important to understand the mechanism of arriving at the taxable profit of a company. A quick glance at the P&L account of a company will reveal that income of a company is used to meet the legitimate dues to several stakeholders, in a set hierarchy, before profits can be said to have been generated.
First, the operating cost is met, which involves remuneration to employees, payment to third-party vendors for purchase of goods and services, and indirect tax on goods or services sold. Then comes the financial cost—the payment of interest to lenders. Then come depreciation and amortisation, which, though not payouts, yet are treated as expenses in the profit computation process. What remains thereafter is the profit. This residual income should be the rightful share of its shareholders, and none else, after tax incidence has been met, because they remain the only stakeholders who still have their indulgence in the company unrewarded. The company law permits the return of this cash to shareholders in the shape of dividends and as consideration for shareholders’ shares if the company offers to buy the same.

A similar, but not identical, hierarchy of priorities is prescribed in a liquidation event when shareholders statutorily participate in the distribution of whatever is left of liquidation proceeds after meeting the dues to different stakeholders. But tax treatment of the two sets of shareholders’ receipts ends this similarity. Post-liquidation, asset sales proceeds are not subject to tax in the hands of the company, but only to a capital gains tax from the receiving shareholder. However, the company pays the dividend distribution tax (DDT) on proceeds out of the free reserves (read, accumulated tax paid profits) distributed amongst shareholders.

If we remove all other stakeholders from reckoning, after dues to them are met, shareholders are almost akin to owners of remaining profit (both current and free reserves) and liquidation proceeds, respectively. By this logic, they should be taxed only once, either at company’s hands or the shareholders. DDT on the already tax paid (dividend) amount is essentially double taxation and should not be imposed, though India is not the only major country succumbing to the lure of augmenting her tax revenue by resorting to such onerous impositions. Similarly, the tax on buyback amount, extended to listed companies as well in an otherwise forward-looking Budget, is a dampener.
Taxing is tempting, as they say. This government’s intent to usher in brisk economic growth is indubitable. It wants investors, both foreign and domestic, to invest heavily in its Make-in-India initiative and boosting infrastructure development. However, if more than 40% of their hard-earned profits are likely to be evaporated owing to the swindling double tax, it daunts the otherwise fervent investors eyeing to harvest a reasonable fortune from a giant economy buoyed by recent reforms and a large demography.

Despite a leap in the ease of doing business, also recognised by the World Bank, a complex federal structure in India resulting in copious rules still has a labyrinthine and difficult-to-negotiate business regulatory system, especially to a foreign investor. In an era when nations compete for global investments, investors need to be offered something differentially rewarding that offsets the impact of an intricate legal system. Amidst the China-US trade tensions and due to geopolitical reasons, foreign capital, especially Japanese and Korean, is flying out of China, but has not been landing in India. East Asian nations like Vietnam, Thailand, the Philippines and Indonesia have attracted the bulk of it. The government may do an assessment of the contribution of DDT and tax on buyback to total direct tax collection. If it is not that significant, it will be ingenious of the government to do away with these unsavoury fiscal millstones. It does not take a clairvoyant to predict an imminent surge in inflows of foreign capital only on this count and also a stop to Indian capital’s flight to foreign lands. This will help India stand out as an attractive investment destination and help it in garnering the capital it requires for infrastructure development and Make-in-India, which should, in turn, generate employment for the millions entering the workforce every year.

The author is founding partner, Jupiter Law Partners

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