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Rashmin Sanghvi & Associates

Chartered Accountants

109, 1st Floor, Arun Chambers,
Tardeo Road,
Mumbai - 400 034,
Maharashtra, India.

Tel. Nos.: (+91 22) 2351 1878, 2352 5694.

Fax : (+91 22) 2351 5275.

Email : [email protected]

 
Home Articles Taxation         Share :

Budget 1997

A. General :


For Rs. 2,00,000 income, net tax is only 10%

 

1. Tax Rate Reduction

Finance Minister has reduced taxes to a level which nobody expected. Everyone is happy.

A practical example may show current tax position.


    Businessman Rs.   Salary Earner Rs.
Total Taxable Income   2,00,000   2,00,000
Less : Standard Deduction   NIL   20,000
         
Less : Bank Interest U/s.80L   10,000   10,000
         
    1,90,000   1,70,000
         
Tax   32,000   26,000
Contribution for PPF, PF, LIC etc.        
Estimated 30,000                                         
Tax Relief U/s.88   6,000   6,000
Net Tax Payable   26,000   20,000
                                         
Tax as a percentage of income   13%   10%

Exemptions are shown assuming amounts which a normal man can pay into provident fund etc. If reliefs are calculated upto maximum permissible limits; then the tax would be even lower.

For a salary earner, income upto Rs.75,000 is totally tax free. For income upto Rs.2,00,000; the tax payable is just 10% of the Gross income.

In a country where the per capita income is still less than Rs.12,000 per year; one can not expect better tax system.

Seniors would remember a time when citizens were expected by the society to be honest. If any person was raided by revenue department, it was considered a "Shame".

Then came the usurious tax rates of 97.5% income-tax, 8% wealth tax and 85% estate duty. Everyone - well, almost everyone evaded tax. In any case, tax evasion and absurd tax planning became fashionable.

Now again, the times will come when the society will expect people to be honest. A dishonest man will be looked down upon. A chartered accountant advising dishonest methods will be in even worse position.

     

The Finance Minister has made capital market attractive for all

 

Competition for capital

Professionals and industrialists have been proclaiming that.

"In today's global markets, capital is scarce. Gone are the days when Governments could pass the laws and order the capital to stay within. Now Governments have to compete in the market to attract capital. And they have to make their markets attractive - for foreigners, non-residents as well as for their own residents."

Now that we have a "professional" as the "Finance Minister", he has made Indian capital market attractive for all.

Tax reductions have been accompanied with a wide amnesty scheme

"Past is forgiven. For future, you have low taxes."

Very inviting.

     

India has become competitive compared to industrialised countries

 

2. New Tax Rates

2.1 The maximum tax rates have been reduced for all assessees. The following are the rates of taxes for different assessees.


Tax Rates
Person   Present   Proposed
Individual, HUF, AOP Income        
Upto Rs. 40,000/-   NIL   NIL
Rs. 40,000/- to 60,000/-   15%   10%
Rs. 60,000/- to 1,20,000/-   30%   20%
Rs. 1,20,000/- to 1,50,000/-   40%   20%
Above Rs. 1,50,000/-   40%   30%
- Partnership Firms   40%   35%
- Indian Companies   43%   35%
    (Including Surcharge)   (Surcharge Nil)
- Foreign Companies   55%   48%

2.2 With these reductions, India has become very competitive as compared to several industrialised countries.

Many developed countries have tax rates exceeding 50%. Further, not only does the centre levy income tax, but even states and municipalities levy income tax. The U.S.A. and Canada levy estate duty also. The rate can exceed 50%. A lot of planning is done to avoid estate duty. As compared to the industrialised countries, India levies tax only at the central government level. There in practically no wealth tax. There is no estate duty.

2.3 The reduction of taxes all around should give a strong incentive to persons to disclose their incomes. The reduction in taxes coupled with reduction in customs and excise duties, should reduce the costs. The entire economy should benefit. These reductions should help in creating a virtuous cycle of lower costs -> higher demand -> higher investment -> higher profits -> higher tax revenues -> reduced deficits -> lower inflation -> lower costs -> ..

     

The whole system of dividend has been simplified

 

3. Tax on dividends [S.10(33) and S.115-0]

3.1 The Industry and Chambers of Commerce have for quite some years been lobbying for abolishing tax on dividends, as it amounts to double taxation. This demand has been met by the Finance Minister by abolishing tax on dividends in the hands of shareholders.

The tax has been abolished for all persons - individuals, companies, residents and non-residents. In place of the exemption, the Finance Minister has introduced a tax on dividends to be paid by companies declaring the dividends. The companies will have to pay tax @ 10% of the dividends declared - within 14 days of declaring dividends.

At one stroke, the Finance Minister has simplified the taxation of dividends, removed the botheration of TDS, made the collection of tax simpler and perhaps increased the total tax revenue out of dividends. (see para 3.2.1).

Para 3.1 may interest all.

Para 3.2 to 3.8 are complex and meant for corporate clients, professional friends and people with substantial investments.

Government should get more revenue under the new system of tax on dividends

 

3.2 The new system of tax will have different implications. Some of these are discussed below :

3.2.1 The shares of Indian companies are normally held by different share holders as under :


Shareholders   Shares in
Government   PSUs, large corporations
like ONGC, SAIL, Indian Oil.
UTI, LIC, etc.   Several large companies.
Financial Institutions
(ICICI, IFCI, etc.)
  Several companies
Together with UTI, LIC,
they hold upto 40% of the
shares of many companies).
Indian companies   Indian companies.
FIIs   PSUs, Indian companies
(Nominal amounts).
Other shareholders -
individuals
  Nominal shares in
Indian companies.

The Government of India is exempt from tax. UTI, LIC, etc. are also exempt from tax as per the acts vide which these corporations are formed.

Under Section 80M, companies earning dividends get exemption from income-tax. (Section 80M is deleted with effect from A.Y. 1998-99)

Individuals get relief under section 80L.

Thus only a small portion of dividends was taxed.

Now the dividends declared by the companies will be straight away taxed at the source @ 10%. There are no reliefs, no deductions. Hence the net tax revenue under new system should be much more than the revenue in the old system.


   

3.2.2 Tax payable by the companies on dividends is not deductible as expenditure in the hands of the company. Hence probably the companies may cut down the rate of dividends. Those investors whose dividend was in any case exempted from tax due to relief under Section 80L, may get less dividends.

Investors in high tax bracket will benefit

 

3.2.3 Those investors with large dividend income, who are liable to tax, will however benefit. An example is given below :

    Old system   New System
Dividend declared
Tax on dividend by company
  1,000
-
  1,000
100
Total outflow   1,000   1,100
To conserve funds, the company
may declare dividend of only-say
      900
Tax on dividend       90
                 
Total outflow       990
Shareholder Dividend received   1,000   900
Tax @ 30%        300            --
Net funds       700       900

Thus shareholders in high tax brackets will benefit.

Corporate holdings may be re-structured

 

3.2.4 In case of an Indian company which received dividends from another Indian company, relief was available in the form of section 80M. If the company receiving the dividend, also pays dividend, then to the extent of payment of dividend, a deduction was available. Effectively there was no double taxation on dividends in case of companies.

It is proposed to remove this benefit. Hence now both the companies will have to pay tax on declaration of dividends. This will create a multiple incidence of tax in case of vertical sholdings and cross holdings of a company.

To give an example, let us assume that company S is a subsidiary of holding company H. S pays a dividend of Rs. 1,000/- to H. H declares a dividend to its shareholders of say Rs.2,000/-. (H has other incomes also.) The tax under the old and new system is explained below.


    Old Rs.   New Rs.
- Dividend received by H   1,000   1,000
Less : Deduction U/s. 80-M
(as H has in turn paid
dividend of Rs.2,000.)
       
Restricted to   1,000   --
                       
Balance Taxable Income   NIL   1,000
    NIL   NIL
Tax by the company paying dividend        
- by S on Rs.1,000 @ 10%
- by H on Rs.2,000 @ 10%
  --
--
  100
200
Total taxes           NIL           300
         
         

Thus, under the old system, there would be no tax on dividends. Under the new system, a double tax will be payable on the same dividend amount. It would be fair to avoid multiple tax on dividend by merging S.80M into S.1150. This suggestion is explained by an example given below :

In the following situation, exemption should be granted U/s.1150 :

Company "H" receives dividend from another company - "S". "S" has already paid tax u/s. 1150. Now, when "H" declares a dividend, it should get a deduction equivalent to the amount of dividend received from "S".

The above is a very simple illustration. In case of multiple layers, the tax incidence may rise substantially. There will be a similar situation in case of cross-holdings.

This may result in corporate holding structures being reworked. From vertical holdings, the structures may be horizontal, wherein there will be a tax at only one level & not at multiple levels.

UTI may not be liable to pay tax under Section 115-O


Unit holder will be liable to pay tax on Unit dividend

 

3.2.5 There was a controversy regarding application of this provision to Unit Trust of India (UTI). This is because of the controversy regarding UTI itself. If UTI is treated as a company, then this provision will apply and it will be liable to pay tax of 10% on dividend under Section 115-O.

Due to various provisions under the UTI act, it was regarded as a company.

The preamble to UTI Act mentions that the act is for establishing a "Corporation".

Section 3(1) of the UTI Act mentions that the Central Government by notification shall establish a corporation which shall be a "body corporate."

Section 32(3)(b) of the UTI Act mentions that the trust shall deemed to be a company.

At the time of passing the Finance Bill, Section 32(3) has been deleted. The objective is that the UTI will not be treated as a company. Hence it will not be liable to pay tax of 10% under Section 115-O.

Consequently unit holders who will receive any income from UTI will be liable to pay tax. Normal relief under Section 80L will be available.

The changes are however insufficient in our view. The other relevant provisions have not been changed. Consider :

Income-tax Act

S.2(26)(ia) - A corporation established under a Central Act is considered an "Indian Company". Hence UTI is an Indian Company.

S.2(22A) - A domestic company means an Indian Company.

S.115-O - A domestic company is liable to pay 10% tax on dividends declared by it.

UTI Act - The preamble to the UTI Act and S.3(1) of the UTI Act clearly state that UTI is a corporation established under the UTI Act.

When all these sections are considered together, UTI may still, be considered a domestic company and hence liable to pay tax under Section 115-O.

Such an interpretation would be directly against the purpose and intention of the parliament in amending the UTI Act and deleting S.32(3).

This issue is mentioned here just to point out that the amendment made by the Finance Act, 1997 is not complete.

Normally in case of all units of mutual funds, the concept is that, the investors come together to invest in shares or securities of Indian companies. Mutual fund is just a "pass through" entity. Hence income earned by mutual fund is exempt from tax. The income earned by unit holders from mutual funds is liable to tax - subject to deduction under Section 80L.

Thus the situation is as under :


Dividends paid by   Tax by Co./UTI/MF   Taxable in receiver's hand   Relief U/s. 80L
Indian Company   Yes   No   N.A.
Foreign Company   No   Yes   N.A.
UTI   No   Yes   Yes
Indian Mutual Fund   No   Yes   Yes
Foreign Mutual Fund   No   Yes   No

3.2.6 Currently there are few tax free incomes which one can earn - PPF & tax-free bonds. With dividends proposed to be exempt from tax, preference shares may become attractive. Tax free bonds offer 10 - 11 percent rate of interest. PPF offers 12%. Even preference shares can be issued carrying a dividend of more than 12%. Hence these securities can become more popular.

Constitutional validity of "dividend tax" may be challenged only 10%

 

3.3 Dividends from companies are exempted from tax. However, dividends from units of mutual funds continue to be taxable, subject to relief U/s. 80L. Due to the new system, there can be an adverse impact on mutual funds.

3.4 Under the income tax act, if a company (in which public are not substantially interested), gives a loan to a shareholder who owns at least 10% of the shares, then the loan is treated as dividend. This provision has not been changed. Thus such loans will still be considered as dividend. On such dividends the receiver of the loan will be liable to pay normal tax. No relief will be available under section 80L. Tax will also have to be deducted at source as earlier.

3.5 Companies which are not liable to pay tax will now, have to pay tax on dividends e.g. A company earning agricultural income is not liable to tax. Now it will have to pay tax @ 10% if it declares dividend. Shareholders will of course not be liable to tax.

3.6 Dividends declared by a co-operative society continues to be taxable. Co-operative societies are not liable to tax on dividends declared.

3.7 Under the constitution of India, the Central Government is empowered to levy income-tax. For this purpose, Income-tax Act is enacted. Under this Act, no amounts other than "income" can be taxed. Dividend is an "application of income" by the Company and certainly not an income in the hands of the company. Hence it is possible that if challenged, courts may strike down S.115O as unconstitutional.

An argument in favour of "constitutionality" of S.115O may be that -

- This tax is in addition to the normal tax. Just as agricultural income is added by the Central Government for "rate" purposes ; dividends also may be taxed.

This is a controversial issue and may take a long time before it is clarified.

3.8 Tax on dividends is considered as an "additional tax", over and above the corporate tax. There is a view that if a company is not liable to tax, then it cannot be liable to "additional tax". UTI, or companies having agricultural income, or companies having losses are not liable to income tax. Hence they are not liable to "additional tax" on dividends.

However, there is an increasing trend by the courts to go by spirit of the law and not to rely on too technical interpretations. Hence the above contention may not hold good.

At the time of passing of the Finance Bill in the Parliament, it has been provided that even if a company does not pay tax due to any reason, tax on dividend will have to be paid.

3.9 There could have been a slight improvement in the system by adopting a more complicated system. In case of U.K., a company which pays dividends, has to pay an advance corporation tax (ACT) @ 25%. This ACT can be set off against the corporate tax (tax on the company's profits). Further the ACT in passed on to the shareholder who can take credit for the same.

If the dividend declared is - say U.K. Pounds 1,000, then ACT will be U.K. Pounds 250. This ACT of 250 can be used to set off the companies tax on profits. Further in case of a shareholder, the dividend will be considered as 1,250. Out of which 250 in considered as TDS, which can be set off against his personal tax.

But one cannot ask for every thing. By and large, the present simplified system should be much more simpler to administer.

     

Filing of returns is compulsory for some categories of persons

 

4. Mandatory Filing of returns

Normally persons who are below the taxable limits do not file income tax returns. Now persons who satisfy certain criteria will have to file the income tax returns, even if their incomes are below the taxable limits. Persons residing in specified areas (these areas will be notified later) who fulfill any two of the following conditions will be liable to file the income tax returns.

- Person is in occupation of an immovable property exceeding a certain area - whether as owner, tenant or otherwise. The area of the property will be specified later.

- Person owns a motor vehicle or has taken it on lease.

- Person is a subscriber to a telephone.

- Person has incurred expenditure for himself or any other person on travel to any foreign country.

If such person fails to file the return, he shall be punishable with a penalty of Rs. 500/-.

This provision is to basically bring more assessees into the tax net.

It is apparent that NRIs will not be covered by this condition even if they have a residential house, car and telephone in India.


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