THE progressive rate of taxation is one of the cardinal principles of taxation, charging more tax from the rich, moderate rates from the middle class and excluding the poor and the marginalized altogether from direct tax net. It is based on the principle, “from each according to his capacity.” However, this principle has been given a go bye in the recent past. One such case in point is the tax on dividend.

A domestic company which declares, distributes or pays dividend on or after April 1, 2003 is bound to deduct tax at a rate of 15% on the total dividend paid to the shareholders and the same is exempt from tax in the hands of the shareholders u/s 10(34). That means that tax is deducted uniformly at the same rate whether one is a taxpayer or not. Moreover, to add insult to injury, there is no provision in the Income Tax Act to claim refund for a person who is in receipt of dividend and whose income is below the taxable limit. It may be noted that there are a lot of senior citizens, pensioners, widows who have invested in shares of some companies and receive regular income by way of dividend and at the same time they have no taxable income. For them, dividend tax is unjustly deducted from their dividend income. For such persons who receive dividend, but have no taxable income, there must be a provision in the Income Tax Act either to claim refund or go through a mechanism for non-deduction of tax by the company distributing dividend by production of a non-tax deduction certificate from the assessing officer.

Another aspect of dividend tax is tax is deducted at a flat rate of 15% from the dividend paid to the rich taxpayers who, otherwise, have to pay tax at maximum marginal rate of 33%, including surcharge and education cess. Most of such tax payers are the promoters or large shareholders of companies. These promoters and large shareholders receive lakhs and crores of income by the way of dividend and such income is taxed only at 15%. The argument put forward by them is that the income that they receive in the form of dividend is taxed twice, once in the hands of the company and again the same income is taxed in their individual hands when dividend is received. Such an argument does not hold water since as per law, the company and the shareholders are two distinct legal entities. The tax paid by the company is on the income earned by the company and the tax paid by the promoters and large shareholders is on their individual income.  Had it been the case of a firm and its partners, there is a force in such an argument since there is no distinction in law between the partners and firm. The firm and the partners work on the principle-all for one and one for all. But in the case of companies and their shareholders this principle is not applicable. Of course, the dividend paid by a subsidiary company to a holding company cannot again be taxed in the hands of the holding company.

Adam Smith, in his classic, “Wealth of Nations” says that one of the main objectives that should be borne in mind by the state in levying taxes is equity. The taxes must be equitable and fair between different classes of society. Here is a classic case where tax on dividend is not equitable and the rich are let off by paying less tax than what they ought to have paid to the exchequer. This anomaly needs to be set right in the forthcoming Budget. By taxing dividend of the rich at the maximum marginal rate, the government would be able to collect a substantial revenue when there is such a huge revenue deficit.