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CAG sees no holes in Sinha's dividend tax

Subhomoy Bhattacharjee

Finance Minister Yashwant Sinha has international best practices on his side in the move to tax dividend income in the hands of taxpayers, according to a report of the Comptroller and Auditor-General.

In its analysis of dividend tax, the CAG has said the 1997 Budget decision to abolish the practice of taxing dividends in the hands of shareholders and levying an additional tax of 10 per cent on distributed profits of companies was based on insufficient facts and incorrect assumptions.

The special study on the issue says in a majority of countries including the US, the UK, Germany, France and even Asian countries like Indonesia and Malaysia there is a system of double taxation of dividends.

In other words, dividends are taxed in the form of corporate profits and in the hands of shareholders while there is limited protection from taxation in respect of inter-corporate dividends.

With effect from June 1, 1997, the Centre had switched over from a withholding tax of dividends in the hands of shareholders to a system of a 10 per cent additional tax on distributed profits of companies.

In a significant comment, the report says there are no specific reasons recorded in the files of the finance ministry in favour of this decision.

While the CAG will give its comment on the reversal of the policy only next year, the analysis makes it obvious that the supreme auditor has taken a bleak view of the step.

CAG says the finance ministry documents show that the government had debated on two alternatives. The first was levying a permanent withholding tax on dividends to be collected by companies. The other was a dividend tax to be levied at a flat rate on distributed profits.

Sinha has, however, in this Budget chosen to ignore the notes of his ministry that said taxing dividends in the hands of numerous shareholders will be difficult as it will cost time and need additional manpower.

The CAG has said that taxing distributed profits "tends to be unfair "as shareholders whose personal income tax rates are lower would be unequally taxed as compared to high income shareholders".

But the analysis shows that the government's examination of the entire dividend income issue has been repeatedly inaccurate.

The report says that the impact on revenue of a change in dividend as well as the calculation of the total dividend payouts by companies was faulty.

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