Dividend tax: dividend tax relief, 2006 dividend rate tax, stock dividend tax

The dividend tax has changed the behavior of companies where they must account for this tax. Some jurisdictions apply a withholding tax to ensure collection of the dividend tax. The characterization of the dividend income and associated tax rate provides an incentive to plan and structure distributions from a company to its investors/shareholders to achieve a characterization with the least tax impact.

Collection

In many jurisdictions, the government requires the company to withhold at least the standard tax, paying this to the national revenue authorities and paying out only the balance to shareholders.

Characterization of dividend income

In most jurisdictions world-wide, dividend payments are considered ordinary income and are taxed as such, the same as if the taxpayer had earned the income working at a job. Other jurisdictions separate dividend income and characterize it as something other than ordinary income subject to different tax rates if taxed at all.

Controversy

Depending on the jurisdiction dividend income along with interest income, collected rents, or other "unearned income" may also be taxed and is the subject of recurring debate as to whether or not these taxes should be eliminated.

Arguments for abolition

Abolitionists argue that a dividend tax amounts to unfair "double taxation", in the sense that the company has already paid a corporation tax on these profits, which means that the shareholders, as part owners, have likewise been taxed already.^[1]

Another argument is that dividend taxes create a perverse incentive for a corporation to fritter away cash on poor investments rather than returning it to shareholders in dividends.

Arguments to keep the dividend tax

Some who want to keep the dividend tax as-is claim it is unfair to tax income generated through active work at a higher rate than income generated through less active means or that companies may not have paid their full share of income tax.

Their argument is that such a taxation can help the wealthiest of individuals who can afford to buy large quantities of stock as they could feasibly live off the dividend payments without any income tax on their earnings.

Another aspect that is argued is that the taxation is not unique in being "double taxed" as there are many instances where the same cash flow is being taxed and to focus on this with such scrutiny while characterizing it as unique marginalizes other points of taxation.

Additionally, there is also the argument that dividend tax is completely voluntary and, as such, is worth exactly what is paid. A business can choose to form under various forms that are not separately taxed (e.g., S corporation, limited liability company, sole proprietorship and partnership). However, these flow-through entities do not offer investors the same liability protection, freedom to transfer shares, and ability to create different classes of equity. Accordingly, it is argued that an entity has no intrinsic right to those benefits and dividend tax is merely the cost to access those benefits.

Double Taxation terminology

The term "double taxation" is sometimes used (unconventionally^[2]), mainly in the USA, by advocates of the removal of dividend income tax for investors.

Due to the debate over the dividend tax, US usage of the term "double taxation", in recent years, has focused on the dividend tax (though not exclusively). In fact, the same cash stream is often taxed any time it exchanges hands in many other instances. For example, the consumer or retailer pay sales taxes when the goods are purchased and then the business has to pay income tax on it before the dividends are paid out or the company uses the same cash income to reinvest which is also taxed. The term "double taxation" is rarely applied to instances other than the taxation of dividends. The word "double" also directly implies redundancy.

United States

In 2003, President George W. Bush proposed to eliminate the U.S. dividend tax saying that "double taxation is bad for our economy and falls especially hard on retired people". He also argued that while "it's fair to tax a company's profits, it's not fair to double-tax by taxing the shareholder on the same profits."[3]

Soon after, Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, which included some of the cuts Bush requested and which he signed into law on May 28, 2003. Under the new law, qualified dividends are taxed at a 15 percent rate for most individual taxpayers. Qualified Dividends received by low income individuals are taxed at a five percent rate until December 31, 2007 and become fully untaxed in 2008. The 15% tax rate was set to expire December 31, 2008. However, with the Tax Increase Prevention and Reconciliation Act of 2005, the lower tax rate was extended until the end of 2010.

Canada

In Canada, there is taxation of dividends, but tax policy attempts to compensate for this through the Dividend Tax Credit or DTC for personal income in dividends from Canadian corporations. An increase to the DTC was announced in the fall of 2005 by Liberal finance minister Ralph Goodale just prior to the fall of the Liberal minority government, in conjunction with the announcement that Canadian income trusts would not become subject to dividend taxation as had been feared. Effective tax rates on dividends will now range from as low as 3% to over 30% depending on income level and different provincial tax rates and credits.

India

In India, earlier dividends were taxed in the hands of the recipient as any other income. However since 1 June 1997, all domestic companies were liable to pay a dividend distribution tax on the profits distributed as dividends resulting in a smaller net dividend to the recipients. The rate of taxation alternated between 10% and 20%^[3] until the tax was abolished with effect from 31 March 2002.^[4] The dividend distribution tax was also extended to dividends distributed since 1 June 1999 by domestic mutual funds, with the rate alternating between 10% and 20%^[3] in line with the rate for companies, up to 31 March 2002. However, dividends from open-ended equity oriented funds distributed between 1 April 1999 to 31 March 2002 were not taxed.^[5] Hence the dividends received from domestic companies since 1 June 1997, and domestic mutual funds since 1 June 1999, were made non-taxable in the hands of the recipients to avoid double-taxation, until 31 March 2002.^[6]

The budget for the financial year 2002–2003 proposed the removal of dividend distribution tax bringing back the regime of dividends being taxed in the hands of the recipients and the Finance Act 2002 implemented the proposal for dividends distributed since 1 April 2002. This fueled negative sentiments in the Indian share markets causing stock prices to go down.^[7] However the next year there were wide expectations for the budget to be friendlier to the markets^[8] and the dividend distribution tax was reintroduced.

Hence the dividends received from domestic companies and mutual funds since 1 April 2003 were again made non-taxable at the hands of the recipients.^[9] However the new dividend distribution tax rate for companies was higher at 12.5%,^[3] and was increased with effect from 1 April 2007 to 15%^[3].^[10] Also, the funds of the Unit Trust of India and open-ended equity oriented funds were kept out of the tax net^{[verification needed]}. The taxation rate for mutual funds was originally 12.5%^[3] but was increased to 20%^[3] for dividends distributed to entities other than individuals with effect from 9 July 2004.^[11] With effect from 1 June 2006 all equity oriented funds were kept out of the tax net but the tax rate was increased to 25%^[3] for money market and liquid funds with effect from 1 April 2007.^[12]

Dividend income received by domestic companies until 31 March 1997 carried a deduction in computing the taxable income but the provision was removed with the advent of the dividend distribution tax.^[13] A deduction to the extent of received dividends redistributed in turn to their shareholders resurfaced briefly from 1 April 2002 to 31 March 2003 during the time the dividend distribution tax was removed to avoid double taxation of the dividends both in the hands of the company and its shareholders^[14] but there has been no similar provision for dividend distribution tax. However the budget for 2008–2009 proposes to remove the double taxation for the specific case of dividends received by a domestic holding company (with no parent company) from a subsidiary that is in turn distributed to its shareholders.^[15]

Other countries

In Finland, the dividend taxation will be in use as of 2005. Income tax is 29% for a stockowner and the total tax will be around 50%.

In the Czech Republic there is a tax of 15% on dividends. This was mean't to be reducing to 12.5% for 2009. According to Leos Jirasek, Senior Trade & Investment Adviser, British Embassy, Prague - Trade & Investment Section, the Parliament of the Czech Republic will be discussing an amendment to the Tax Act No. 586/1992 as amended on 25 November 2008. If the amendment gets approved, the withholding tax on dividends (part of personal income tax) of physical persons in 2009 will NOT be 12.5%, as specified by the Act No. 261/2007, but will remain 15%.

In Slovakia, tax residents' income from dividends is not subject to income taxation in the Slovak Republic pursuant to Article 12 Section 7 Letter c) for legal entities and to Article 3 Section 2 Letter c) for individual entities of Income Tax Act No. 595/2003 Coll. as amended. This applies to dividends from profits relating to the calendar year 2004 onwards (regardless of when the dividends were actually paid out). Before that, dividends were taxed as normal income. The stated justification is that tax at 19 percent has already been paid by the company as part of its corporation tax. Foreign resident owners of shares in Slovak companies may have to declare and pay tax in their local jurisdiction. This also doesn't apply to profits made by investment funds.

In Poland there is a tax of 19% on dividends. This rate is equal to the rates of capital gains and other taxes.

In the UK, companies pay corporation tax on their profits and the remainder can be paid to shareholders as dividends. Basic rate tax payers have no further tax to pay as the dividend is deemed to have been received net of 10% tax. For higher-rate taxpayers, additional tax must be paid at 22.5% of the net dividend received (32.5% less the 10% deemed tax deduction, calculated on the deemed gross payment of the dividend).

In the Republic of Ireland, companies paying dividends must generally withhold tax at the standard rate (as of 2007, 20%) from the dividend and issue a tax voucher to include details of the tax paid. A person not liable to tax can reclaim it at the end of year, while a person liable to a higher rate of tax must declare it and pay the difference.

In Australia dividends are taxed at the recipient's marginal tax rate (up to 46.5% from 1 July 2006). Australia (like New Zealand) has a Dividend Imputation system which allows franking credits to be attached to dividends. This allows recipients of franked dividends to impute (or credit) the corporate tax paid by the paying company. A recipient of a fully franked dividend on the top marginal tax rate will effectively pay only about 23% tax on the cash amount of the dividend.

Dividend tax

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