By shifting the burden of tax on dividend from payer to payee the government has, perhaps unintentionally, told companies to cut their dividend payout ratios.
That’s because the difference between the tax rate on dividends and capital gains is now very significant. Therefore, investors should prefer capital gains over dividends. And many (though not all) shareholder-friendly companies should also think similarly.
Dividends are discretionary and the decision makers will not only think of the larger interests of minority stockholders, they would also think of personal interests. For many companies which are controlled by families the personal factor could easily dominate the decision.
I think it’s entirely possible that total tax collected from dividends will actually decrease because many investors who receive dividends are not required to pay any income tax and also because dividend payout ratios should decline.
Dividend distribution tax had other advantages. No collection costs. No leakages. By shifting the burden to payees, both collection costs and tax leakage will increase.
By making these changes, the government is effectively (and perhaps unintentionally) nudging companies to retain earnings.
This is yet another application of The Peltzman effect and of its ignorance amongst regulators and governments. Over the years I have cited many other examples here.
If earnings retention increase in response to these changes, then what will happen to those incremental retained earnings?I think it would be wrong to assume they would automatically be invested in capacity creation. There are other uses e.g.reducing debt and/or building treasury
Needless to say, there would be plenty of misallocation of capital because of these changes. The desire to minimise taxes will override everything else. Not all earnings retention will be sensible. But they would be retained anyway.
