By Sunil K Parameswaran
Interest paid by firms on bonds, debentures, and bank loans is a tax deductible expense, although dividends paid to preferred and equity shareholders is not. Consequently, interest on debt or borrowed capital offers the issuer a tax shield and brings down helpful expense. Thus, debt is less expensive than equity and if a firm assumes more debt, it can bring down its expense of capital.
However, there is no unanimity on how returns from securities must be taxed at the hands of investors. Interest or coupons received by investors is taxed at the hands of the recipients. The logic is that this money flow stream has come out of the pre-tax earnings of the issuing firm, and consequently must be taxed at least after.
Equity dividends, nevertheless, are taxed at the hands of the recipient in particular nations. The very same is accurate for dividends on preferred shares. The rationale for not taxing them at the hands of the recipients is that they have currently been taxed after. The counter viewpoint is that though they are generated out of post-tax earnings at the level of the firm, they are nonetheless earnings for the investors and consequently must be taxed once again. In some nations there is a dividend distribution tax (DDT).
This tax is paid by the organization remitting the dividends, and in such circumstances shareholders do not have to spend earnings tax on dividend earnings received by them. In this case all shareholders face an identical tax burden. However, if person shareholders have to spend tax on dividend earnings, the levy would rely on the tax bracket in which they fall. Consequently, folks in decrease tax brackets would spend tax on dividends at a decrease price.
In particular nations corporate shareholders are exempted from paying earnings tax on preferred and equity dividends. The dividends received constitute earnings for a corporate shareholder. If they are taxed at its hands, the very same rupee has been taxed twice. At some stage this earnings will kind a supply of the dividends paid by it to its shareholders. If person shareholders are essential to spend taxes on dividend earnings, it would imply that the very same rupee will be taxed thrice. Thus, in particular nations, dividend earnings, or a portion of it, received by corporate shareholders is tax cost-free. However, such earnings is taxable at the hands of person shareholders.
The writer is CEO, Tarheel Consultancy Services