Tax rates on corporate payouts are set to head higher; increase in the dividend tax has been one of the many tax proposals in the FY18 budget. While this column has talked about the impact of corporate, super, and dividend taxes on overall effective tax rates, today’s article talks about the dividend taxation in particular.

While dividend tax is not the only reason for higher effective tax rate, it sure is a source of concern for the investors – their total return decreases. In the FY18 budget, the government has increased dividend tax from 12.5 percent to 15 percent with minimum payout ratio of 40 percent. This was the second consecutive increase in the rate in the last two budgets; the previous increase was from 10 percent in FY16 to 12.5 percent in FY17. Also, the cascading structure of capital gain tax has been replaced with a uniform CGT of 15 percent for the filers and 20 percent for non-filers irrespective of holding periods in the latest budget, raising the taxes paid by the shareholders.

The increased dividend tax came contrary to what the market and the experts suggested. A glance at the illustration shows the component of effective tax rates; while the government has brought down the corporate tax rates continuously each year since FY13 and has taken steps to increase dividend payout (at least 40 percent ratio); the existence of super tax and the rise in dividend tax eat away the gains.

Taxing the dividends this way means ‘double taxation’ of earnings – once at the corporate level, and then at the individual level – which leads to higher taxation, and thus going against the objective of documentation in the corporate sector. On the other hand, the condition of minimum payout ratio repeatedly penalizes the shareholders who want their companies to reinvest in expansion projects and business in pursuit of long-term returns.

There is a need to bring down the effective tax rates by tightening the screws on its components. While there is no right or wrong way to approach dividend taxation, the progressive world is moving towards lower dividend tax rates as after-tax returns are the most relevant to the taxable investors. Majority of the top companies in the country are paying good dividends, so it makes all the sense to rationalize dividend taxes.

Across the world, countries tax corporate dividends in different ways: some countries tax both capital gains and dividends, while others only have CGT. Hong Kong is one country that levies none, while Singapore and India have no dividend tax; the US has a double- tax system, which has moved from a very high dividend tax (39 percent) versus the capital gain to a point where taxes on both are the same (15 percent).

Another model is the dividend imputation tax system like that in Australia and France, which ensures that the corporate dividends are paid at the corporate level but are attributed to the shareholder, so that all taxes are effectively paid at the shareholder rate. Shareholders receive a tax credit for the taxes that the corporation paid on distributed earnings.