Calling for conducive tax structures to attract equity investments, Confederation of Indian Industry (CII) said that tax incidence on equity needs to be lowered to incentivize risk capital in the economy.
“The current taxation system favors debt funding over equity investments, thus encouraging greater debt in the economy. With lower taxation on equity, investors would bring in more risk capital which in turn will drive economic growth,” stated Mr Chandrajit Banerjee, Director General, CII.
As a matter of principle, any equity returns earned by an enterprise or individual are subject to tax. On the other hand, debt interest incurred by a company gets a tax deduction. In India, equity earnings are subject to tax at four different levels, pointed out CII.
First is the corporate tax rate which currently stands at about 35% for larger companies. Secondly, Dividend Distribution Tax of around 20% is applicable on any profits distributed by the company to the shareholders. Third, in the hands of an investor, if the dividend received is more than Rs 10 lakhs, there is an additional tax levy of 10%. Fourth, when the investor sells his equity after holding on to it for 12 months (for listed shares) or 24 months (for unlisted shares), a long term capital gains tax of 10% is applied on the profit amount exceeding Rs 1 lakh.
This imposes a high burden on equity investments. CII suggests various measures that could be taken up in the upcoming Budget for a more balanced approach to sourcing funds.
First, CII reiterates that the tax rate on all corporate taxpayers should be reduced to 25% unconditionally without any turnover criteria at the earliest. Further, this should be brought down to 18% in a phased manner with simultaneous elimination of exemptions.
Two, CII recommends that dividend distribution tax should be brought down from 20% to 10% in the Budget. This would move towards reintroducing the classical tax system, where income tax is levied separately, both on company income and on dividends received by shareholders. It is a simple and transparent method of taxing dividends that promotes greater equity by taxing the recipient of the income as per the applicable slab rate. It reduces the overall tax burden on the companies, and even avoids the cascading impact of taxes.
Three, to encourage taxpayers to invest in mutual funds and shares, the gains from sale of such units/shares should be made more tax-friendly by removing the taxability on sale of long term capital assets, suggests CII.
Since the tax incidence on equity investments in India is high, companies are more comfortable with sourcing funds through debt. As a result, there is a lack of risk capital within the country for building new businesses or expanding existing businesses, according to CII. Increasing dependence on credit has also led to rising non-performing assets of banks, which doubled from 5.1 per cent of total bank advances in September 2015 to 10.8 per cent in a period of three years.
In order to kick start the economy, and to encourage investments, CII recommends that the cost of equity should be reduced, so that investors are encouraged to take equity risks at a time when raising the growth rate is of utmost importance.
27 June 2019