The dividend fiasco

The controversy over the declaration of dividends by companies before the changes in dividend tax policy took effect from April 1 might have ended but a few substantive issues remain. The Finance Minister in his budget speech had decided to shift the incidence of the direct tax to those who actually receive them. That was the situation obtaining until a few years ago before the dividend tax was abolished (as part of a "dream'' budget).

It was the interrugnum — between the budget speech and April 1 — that presented a few opportunities to company managements and (as it turned out) challenges to the financial system's regulators and the Government. It all started with companies rushing in with generous interim dividend announcements. If they had succeeded in paying out, their shareholders would have received, as in the immediate preceding years, a tax free dividend. Generous and investor friendly as the gesture of the companies appeared to be, there was a catch. Listed companies, which assumed that the stock exchanges where their shares are trading would give them the permission, were disappointed. The rule is that the companies have to give notice of a record date to the exchanges which must be at least 30 days after the dividend announcement. If the notice period is to be for a shorter period, the stock exchanges will have to condone it. Although initially there were signs that the exchanges will accord permission — in the past it was fairly routine — they backtracked. Allegedly the Securities and Exchange Board of India, the capital market regulator, was behind this rigorous interpretation of the rules governing quoted shares. Private limited companies have not been affected by this interpretation and went ahead with their generous tax free payouts.

Unresolved issues

The above brings into focus a few key issues. One, too much perhaps, has been read into the shareholder friendly nature of these dividend moves. The dividend figures mentioned were quite high but it should not be forgotten that the biggest chunk of shareholding in most companies is with the promoter group. For them a tax free dividend obviously means more than it does to smaller shareholders.

Two, notwithstanding that, smaller investors are bound to see in this dividend fiasco one more addition to their list of grievances against the latest budget. Especially those who drifted to mutual funds in the wake of the tax breaks given.

Three, as companies whose shares were not listed were unaffected the debate over the perceived disadvantages of listing a share will cover some finer points. Already this year a number of companies, especially the multinationals, are taking away their shares from the Indian exchanges. The dividend fiasco will, however, be just one point in the debate.

Four, more substantial has been the criticism of the SEBI. Did it overdo its brief of a capital market regulator while directing stock exchanges not to condone the reduced notice period? The new Chairman of SEBI, G. N. Bajpai, has made it amply clear that no regulator can ignore public good. Here ensuring that the Exchequer received its share of revenue, even through rather unorthodox means, fitted into its regulatory view. Five, from the point of view of public finance, the Government's stand has been to plug the leakages in revenue collection. In its view paying tax free dividend was tantamount to just that. The budget had clearly not intended that. Estimates of taxes that would have been "lost'', that which would have escaped taxes, ranges between Rs. 2,500 and Rs. 4,000 crores. The issues as to whether the government was "entitled'' to the tax or whether the corporate shareholders were treated whimsically are something that can be debated at length without arriving at a satisfactory solution.

Six, less controversial, is the recommendation to look at the secretarial work connected with dividend and other substantial corporate announcements. Should the duration of the notice period for fixing the record date be shortened in the light of technological advances such as demat, rolling settlement and so on.

Now that dividend income will be taxed in the hands of the receiver, it is time to get an insight into what will happen to stock valuations. There are two diametrically opposite views. The first view is that if companies use the cash (instead of paying stupendous dividends), their stocks will become intrinsically stronger reflecting the productive approach. The other view is that dividends payout are indicative of corporate health. If the quantum of dividends shrinks or if the dividends are brought under tax the company's valuation will suffer. High dividend paying companies, the FMCGs like HLL, Nestles, ITC will be test cases. As also certain other companies like select NBFCs whose scrips people bought only for the dividend. In the latter case, their market quotes will plummet. For the other category of high-dividend paying companies, investors look at capital appreciation too. They will more likely to be less aggressive in their dividend policies and will look at other ways of compensating their shareholders. Share buyback is one way of returning the shareholders money. The more common method is bonus. In both cases, the fact that the dividend tax is back will be just one factor in the decision making process. Surely, one can expect some innovations here like bonus debentures (the HLL style) or a prop up in the share values through the most traditional way of ploughing back the profits.

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