Before a budget presentation and after a budget presentation there is a lot of print, online and television media space which is consumed by economic analysis, tax interpretation and advice and stock and industry recommendations. We are currently in the midst of such a season and I do not have much to say other than what is already out there.

A single point that I would like to delve upon is that of the taxation of dividends. The taxation of dividends as it stands today is at multiple levels. A company pays tax on its profits (corporate income tax), the company again pays a dividend distribution tax and finally the recipient of the dividend pays tax again if the aggregate amount of dividend in a financial year is in excess of Rs 10 lakh. This has been called a triple tax and there was a lot of angst against it.

As per the proposed provisions, dividend distribution tax has been abolished. The dividend henceforth will be taxed in the hands of the person receiving the dividend as per the normal tax rates. Hence, in a way we have moved from three layers of taxation to two layers of taxation. As per the budget speech of the finance minister, the loss on account this change will be to the tune of Rs 25,000 crore to the exchequer. So far so good.

However, the reaction of vocal voices in the market was perplexing on this front. As they say, the devil is in the detail. Overall I think that there is no doubt that the government will give up some revenue on account of this measure. Small investors getting not so high amounts of dividends will be better off and foreign investors and MNCs will benefit in a big way. But there is a set of people who will be worse off. Since dividend income will be taxed at the usual tax rates, promoters of companies holding shares in individual names and HNIs will end up paying tax at around 42.7 percent of the dividend amount which is higher than what was being paid before.

Two tax regimes

This may end up having certain unintended consequences going forward. While PSUs and MNCs will continue to pay dividends as before, certain private sector companies where a promoter group is holding shares in individual names may be tempted to reduce dividend payouts or go the buyback route. This may end up with minority shareholders having to live with bad capital allocation so that the promoter group is able to save on taxes.

With the tax cuts on corporates announced in September 2019, India is among countries with attractive corporate tax rates. However, coporates now have two tax regimes to choose from. The distortions due to tax on dividends take away some of the attraction of the low corporate tax rates. Individuals also will now have two tax regimes to choose from. This has added some complexity to the system which has not been taken too well by the market participants.

It may be a while before participants get used to the new tax environment and things return to business as usual. Going into the budget, market participants had all sorts of expectations from the finance minister. From removal of tax on long term capital gains to abolishing tax on dividends, scrapping policy on old vehicles, reduction of personal income tax, huge infrastructure spend and so on, the finance minister was expected to wave a magic wand to make our problems disappear. The disappointment in the stock markets on February 1 has to be seen in that context.

As Charlie Munger repeatedly says, the secret to happiness in life is to have low expectations. Market participants would do well to keep that in mind for future budgets.

Rajeev Thakkar is Chief Investment Officer and Director at PPFAS Mutual Fund.

First Published:Feb 4, 2020 6:00 AM IST