Budget 2020 for investors: Effects of DDT abolition

The Dividend Distribution Tax

To understand DDT we should understand how an enterprise works. A company that is listed on stock exchange has several shareholders. When this company earns profit it reinvests some amount in its business. The rest of the profit is shared amongst the shareholders. This profit shared amongst shareholders is called ‘dividend.’

Under DDT, this dividend distributed to shareholders is taxed. This DDT is abolished in this budget.

However, this is not the complete picture. This onus of payment of DDT will now be on investors! It means that any money that you earn as dividend will be added to your taxable income and taxed like your income. In fact, the tax will be deducted and the remaining money will be given to you. This is Tax Deducted at Source (TDS).

For equity or equity mutual funds, DDT is 11.65% and, for debt mutual funds, it is 29.16% inclusive of all cess and surcharges. It is clear that people at higher slabs, paying 30% of income tax would lose money. Say if a person receives ₹10,000 as dividend from an equity mutual fund, in FY2020, he would have to pay only ₹ 1,165 as tax. However, if he is in the top slab of 30% tax payment, he will have to pay ₹ 3,000 as tax in FY2021.

Such an action of the government would discourage investors to pick dividend-yielding stocks.

Stocks of DVR (Differential Voting Rights) type, where voters have less say in votes but bigger pie in dividends will be affected because they would now be less in demand. In fact, it is contrary to ‘Ethical Wealth Creation’ emphasized by ‘Economic Survey 2019.’ Someday you get wealthy and invest in certain companies, in the form of ‘preference shares’ or as a ‘Promoter.’ You do not sell the shares in such cases. You depend on vast dividends pouring in for your income. Such wealth creators like you are being unnecessarily penalized.

G-Sec ETFs

Riding on the big success of the Bharat Bonds ETF, the government now plans to open government securities (G-Sec) market to retail investors. This will give retail investors access to the government securities. It will be an alternative investment option for investors who mostly invest in fixed deposits or pension funds.

G-Sec does not carry any credit risk because it is rare for the government to default. However, bi-monthly interest rate changes make it a volatile security. Fortunately, the ETFs have a maturity date and if investors hold to the date, they receive a certain maturity amount promised. Hence, the volatility diminishes.

As cited during the launch of the Bharat Bond ETF that it will develop the debt market in India, opening G-Sec for retail investors is another step in the right direction. 

Tax Slabs

The government has come up with a new set of tax slabs for personal income taxpayers. Though keeping it optional for current taxpayers, the Finance Minister quotes it as a step to end all exemptions in a longer run.

One immediate effect of the announcement was that people started calculating which tax system would save them more money. In no way this should turn out to be another GST where we see multiple slabs, ambiguity, and multiple loopholes.

One aspect of the new tax slabs is that it ends all exemptions. There will be no benefits if you take a home loan, or invest in ELSS (Equity Linked Savings Scheme), or save in Provident Fund (PPF/EPF), or buy National Savings Certificate (NSC), or take insurance and so on.

Also read: PPF New Rules and How will it Benefit You

The major reason such investments are exempt is because they promote savings. Government in India provides nothing to its taxpayers. It does not pay pensions in old age, no insurance in case of untimely death, and no quality medical services. Such exemptions incentivize taxpayers to channelize their savings to invest in such facilities.

In fact, it is the time when the economy is not going well. If home loan exemptions are pulled back, it will discourage people from buying houses. This would pull down the already sluggish demand for various goods and impact worse on unemployment.

The only thing good about the new tax slabs is that it is optional. However, the psyche of the government on removing exemptions needs reworking.

The LIC IPO

Good news is that India’s largest insurance company Life Insurance Corporation of India will go public. This would mean that investors would get a chance to be a part of its growth, while functioning of LIC would become more transparent. The customers would be able to know where their money gets invested. This would better the performance of LIC in the long run. 

Winding Down

Stock market was unwelcoming of the budget 2020. It fell by 2.7%, making it the worst budget say sell out in past 11 budgets.

Though DDT abolition looks good for industries, it burdens the investors. Opening Government Securities for retail investors through ETF is definitely a better decision for the development of the debt market in India. It is a long-term decision.

However, tax slab changes would affect the economy. Removal of exemptions mean that people would not put money in insurance, NSC, EPFs, and so on. Dividends will be taxed on investors. This shows that the government virtually blocks all way for money to go into stock markets; be it through mutual funds or SIP, insurance houses, or pension funds. If inflow of money in these funds gets discouraged, overall flow in stock market through these funds would go down. This would not be good for investors.

Nevertheless, much before the budget the government has come up with packages for all sectors. All we can do is to wait for those steps to fructify.