THE proposed national budget FY 2008-2009, as it appears, has been prepared to address major national economic problems. Adequate budgetary allocation for social safety net, women and children welfare, and disaster management is, indeed, a welcome move by the Finance Advisor.
Higher priority has been given to agriculture and rural development, is the demand of the time. The Finance Advisor have earnestly tried to make the budget people-oriented. As regards fiscal reform, the budget is rightly sympathetic to remove the disparities but the proposed budget hardly has kept any incentives for encouraging new private investment and to boost the capital market of the country.
The Advisor tried to satisfy a portion of the business community by slightly reducing the corporate tax rate but frustrated the entrepreneurs and investors by proposing to increase the corporate tax rate on dividend income. The existing 15 per cent concessional rate has been in force for long. The proposed increase ignores the strong arguments of the public finance economists across the world that dividend in the hand of shareholders should not at all be taxed further, especially when the shareholder is a company.
This double taxation concept is based on the concept that a company, in reality, is not a person and has no independent tax-paying capacity of its own. Companies being conduits, income accrues to their owners, viz shareholders through them. Hence, strictly, there is no rationale for levying a tax on corporate earnings as such and the profits of corporate entities, whether distributed or retained, should be attributed to its shareholders only without further tax. It is irrational to tax the same income twice, once when it is earned by the company in its own assessment and then to subject the taxed income once again to be taxed when it reaches its shareholders, without allowing any concession.
Under income tax law in Bangladesh dividend earnings of a corporate body have been subject to income tax, for the past several years, at a reduced rate of 15 per cent, irrespective of the type of the company. This system remained unchanged for several years, with a deviation in between, when dividend distribution tax was imposed during the period from July 01, 2003 to June 30, 2005.
During that period, dividend income in the hands of shareholders was completely tax-exempted. From July 2005, the old system was revived. Under the latest budget proposal, the Finance Advisor proposed to lift the concession that has been allowed for long, disregarding the established argument of double taxation and taxing the companies at the corporate rate, instead of 15 per cent, though such dividend income is not considered to be a business income for companies under section 28 of our Income Tax Ordinance 1984. The budget has proposed to increase the tax from a flat rate of 15 per cent to 27.5 per cent for public companies, 37.5 per cent for private companies and 45 per cent for financial companies.
A look at the global scenario concerning taxation of dividend, in countries like the UK, the USA, Taiwan, Egypt, Germany, Japan, Thailand, Denmark and Belgium, show that inter-company dividends enjoy tax exemption fully, or are subject to certain specified limit. In Pakistan and Nepal, there is no tax on distributed profits and in some cases like that of the Philippines, dividend income received from a domestic company is exempt from personal income tax. In Mexico too, dividends paid out of profits and already taxed are fully exempt. In India, there has been no constant policy on this issue. Earlier, there was no tax on dividend till 1997 but later, in 2002, the Indian government introduced tax on dividend but with concessions in case of companies, receiving such dividend on the amount and distributing them, in turn, as dividend. Later, from the year 2003, dividend in India has been made tax free in the hand of shareholders and dividend distribution tax has been introduced, which is still in force. The conclusion that emerges from the study of the practices in many countries, dividend income is either wholly or partially tax exempt in the hands of all classes of shareholders or there have some concessions in some way, at least, in respect of inter-company dividends.
Therefore, the Finance Advisor should continue to maintain concessions, in some way or other, on dividend income, when the recipient is a company. Otherwise, the proposal to increase the tax on dividends in the hands of companies is going to be detrimental and will have long-term adverse effect on the overall economy for the following reasons:
-- It would punished distribution of dividend. Although it may encourage retention of profits, but would prohibit free flow of funds into new companies effectively, thereby giving a bias towards non-distribution, especially to the private limited companies.
-- It would encourage debt financing, and not equity financing, as interest payment is deductable from profit, while dividends are not.
--It would discourage formation of any investment and holding company in the country.
--It would discourage corporate buyers in the stock exchange and would have an adverse impact on the capital market of the country.
--Finally, the proposal is not in conformity with the global practice. This change could ultimately cause revenue loss of the government.
The proposal for the imposition of corporate rate on inter-company dividends should, therefore, be withdrawn. The current practice regarding taxation on dividend should be allowed to continue without any change.
The writer, a Chartered Accountant, is a Director, Summit Group. He can be reached at e-mail:
[email protected]
