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Dividends taxed at slab rates to hurt HNIs: Sanctum Wealth

Feb 25, 2020

The budget fell short in providing impactful stimulus to kick-start the economy
Prateek Pant

There were a lot of expectations in various quarters as the Finance Minister presented her second budget in the second innings of this Government. The budget was presented in an extremely tough environment, with GDP Growth at an 11-year low and fiscal deficit under serious stress. As they say, when the going gets tough, the tough get going, and diehard optimists were hoping for an encore of 1991. Capital markets were looking at measures aimed at reviving growth, stimulating private investments and boosting consumption. They were also looking forward to specific measures for the markets that would revive the animal spirits.

Markets disappointed

The budget had a lot on intent and provided a blueprint for the next five years. However, it fell short on providing impactful stimulus to kickstart the economy. The capital markets were disappointed as the budget lacked any significant measure to stimulate demand and did not provide any relief on the Long-Term Capital gains (LTCG) tax. The government had hoped to collect Rs 40,000 crore from the taxation of LTCG when this was originally launched. However, market sources indicate that the actual numbers are nowhere close to it. Revival of sentiments in the capital markets could significantly add to the coffers of the government by robust divestment proceeds of PSEs rather than the traditional thinking around LTCG taxation. The government is hoping to raise an unprecedented Rs 2.1 lakh crore through divestments in FY2020-21 on the back of the IPO for Life Insurance Corporation (LIC); however, it needs supportive capital markets.

The FM has delivered on the promise of removing the dividend distribution tax (DDT) paid by corporates, while making it taxable in the hands of the receiver. This is positive for the high cash flow generating high dividend paying companies as it will reduce the tax leakage while distributing profits. This will also reduce the cost of capital of foreign promoters. However, this is a negative development for high net-worth individuals as the dividend, which was taxed at 15 per cent will now be taxed at the slab rates that are likely to be higher in most cases.

The budget did not have announcements to revive the largest job creating sectors – real estate and automobiles. Leading up to the budget, the FM had announced an outlay of Rs 25,000 crore for the real estate sector to revive distressed projects; however, there were many more expectations around reviving investor demand.

Complex slabs

The biggest announcement of the budget to revive demand was to simplify and reduce the tax burden on middle-class Indians. However, the government appears to have complicated the tax slabs. Under the proposed tax regime, there are seven slabs of different rates as against four slabs earlier. The exemptions and deductions available in the old tax regime are not available should the taxpayer opt for the new tax regime. For a person earning Rs 15 lakhs per annum, our back-of-the-envelope calculation gives a lower tax liability in the older tax regime if he/she opts for most of the exemptions. Thus, the question arises as to whether the change is really bringing down the average tax rate for India’s middle class. In addition, there is a moral hazard if millennials are being incentivized to spend rather than save as they join the workforce.

Investors looking to diversify their domestic portfolio with overseas exposure would face additional tax compliance. The budget has been proposed to levy a 5 per cent tax collection at source for LRS Remittances of over Rs 7 lakh. For salaried employees at higher income brackets, the budget has proposed a combined upper limit on Employers contribution towards EPF, NPS and Superannuation funds at Rs 7.5 lakh. Any additional contribution over this limit would be taxable.

There is still some ambiguity around the newly introduced NRI Tax and its applicability. However, what’s clear is the definition of non-resident. While it was possible to be classified as non-resident earlier by staying out of the country for 183 days, this has now been enhanced to 245 days. This could have major implications on individuals working in Merchant Navy, IT sector projects and NRI entrepreneurs.

The FM acknowledged wealth creators and has put forth a proposal for a taxpayers’ charter with an assurance of respect to them. If we club some of the measures that the government had announced through this financial year, including the corporate tax cuts, this budget may look a lot better.

(The writer is Head of Products and Solutions, Sanctum Wealth Management)