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Bulls want toxic Dividend Distribution Tax out

Thursday, 3 July 2014 - 6:20am IST | Place: Mumbai | Agency: dna

Players say it amounts to double taxation, prompts companies to refrain from giving dividends

As foreign investors once again bet on India 'story', stock markets in the country are on a high. They are not running out of steam as predicted by many, but gaining strength by the day. Every market participant now awaits the budget to give bourses the next big push.

Most of them believe that first budget of the Narendra Modi government will give markets enough steam to run further and create a few more new records.

From 6000 levels on February 4, to a new high of 7732.40 on July 2, the NSE 50-share Nifty has been scaling new peaks after the NDA government came to power, primarily on the back of sustained foreign capital inflows. The 30-share Sensex on Wednesday rose to an all-time peak of 25864.53.

The bull run has also attracted retail investors, though marginally. Over the last couple of years, retail participation has been on a steady decline. Many market players expect the Modi wave to continue in the coming days now that the monsoon has set in, though with a lag of nearly a month.

"The rally has attracted small clusters of retail investors," said a fund manager at a brokerage. However, the government needs to make concerted efforts to do away with lopsided taxes like securities transaction tax (STT) and double-taxation in dividend distribution tax (DDT) to attract more retail participants.

Mutual funds are, however, not subjected to DDT and short-term capital gains tax, hence seen best for retail investors in that sense. In a bid to widen the direct retail investor-base, the markets regulator, Securities and Exchange Board of India (Sebi), has also urged the government to permit pension funds to invest in mutual funds besides lowering STT.

As of now, buyers as well as sellers pay STT on any transaction in the spot or cash market, in futures and options only the seller pays STT. This was introduced by the earlier finance minister, P Chidambaram, in 2005 because he felt investors did not declare their profits and avoided capital gains tax. As of now, the STT on cash purchases or sales is 0.100%, for option is 0.017%, whereas for the (sale) option that has been exercised it's 0.125% and for sale of futures it's 0.01%.

As if this was not enough, in 2007, he also introduced the dividend distribution tax (DDT). While Chidambaram found out ways and means to improve government revenues to match expenditures of his government, market participants had no escape but to continue paying taxes even on taxes already paid.

DDT is one such grey area where the company pays investors the dividends less the 16.995% (due to DDT). It's a deemed tax paid to the government though the income doesn't come as taxable income at the hands of the investors.

Though the DDT is 15%, there is an additional surcharge of 5% and an education cess of 3%.

In the government's double-taxing measures for revenues, many promoter-run companies have refrained from giving out dividends to investors, said Raamdeo Agrawal, joint MD and promoter of Motilal Oswal Financial Services.

Unlike income tax, this tax is extended to all and sundry similar to indirect taxation.

"Whether you are liable to pay tax or not, you are indirectly taxed in DDT, and the government needs to undo the mischief of the previous government," said a fund manager requesting anonymity.

Given the current tax structure, corporates, especially owner-driven ones, have found out ways to escape DDT by not declaring dividends and then mis-allocating funds to other businesses. So we now have two losers, one, the government (in taxes) and second, the investor community that is being deprived of dividends.

Of the 3,200 actively traded listed companies on the BSE, only 1,070 companies declared dividends totalling to Rs 1.32 lakh crore for fiscal 2013-14.

"Cow for her milk, hens for eggs, stocks, by heck, for her dividends," says Agrawal, quoting the "Theory of Investment Value" by John Burr Williams on how a stock derives its value.

What value a stock will have if the company does not pay dividends? asks Agrawal.

In effect, most participants end up punting on the price movement.

The distortion therefore needs to be addressed on a war-footing as many companies have resorted to misappropriation of funds meant for dividends, say most market participants.

One of the key reasons for this being, unlike developed economies where companies are more professionally managed, many companies are promoter-driven, hence they rather opt to not pay dividends as major shareholders are close-knit family members.

"Abolishing DDT would provide investors the incentive to invest in equity," said UR Bhat, managing director at Dalton Capital Advisors (India).

"Let the government abolish DDT and find other ways to improve income either by raising corporate or capital gains taxes, which are not revenue-negative," Agrawal said.

"The move will surely attract retail investors," he said.

Equities involve a high degree of risks compared with debt because as investors one not only benefits from capital appreciation but also gets rewarded in dividends. "By taxing capital that is so important to create jobs, the earlier government has made a mess of everything possible," said a fund manager at a private bank.

Retail investors would be a happier lot if they get higher dividends only if the government makes the ambience conducive and removes bottlenecks like DDT.

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