It’s a season of farm loan waivers…

Uttar Pradesh, Maharashtra, and now Punjab; states that are competing with one another to waive off the burdensome loans small and marginalised farmers owe. Collectively, these three states are likely to shell out over Rs 80,000 crore in bailing out farmers. 

At the grassroots level, many tricks are applied to fit oneself in the definition of “small and marginalised”. The size of farmland is a traditional criterion.

The sad truth is that even after these bailouts, the poor farmer is not going to be rescued from the quandary. This is because many marginal farmers don’t borrow from the institutional sources. As reported by Mint dated June 19, 2017, only 38% of marginal farmers borrow from financial institutions; the rest rely on friends, family members, the local Shylocks, and/or private moneylenders.

For now, the Central Government has remained firm about not providing any support such as a loan-waiver to the State Government in an aim to rein its fiscal deficit target. But it remains to be seen how long it denies assistance in any form. Perhaps, at some point in future, the Central Government may have to assist states in some form or the other. After all, cooperative federalism has always been on the top of the NDA Government’s agenda.

The question is who’s going to pay the cost of loan waivers as the politicians cutting across all parties are busy counting votes?

Sadly, it is the middle class as usual—the easiest target of all Governments every time. They’re effectively sandwiched between the rich and the poor.

Transfer of wealth from rich to poor through genuine economic activities is a welcome development for any nation. It helps countries strike a socio-economic balance that eventually paves the way for faster economic growth and closing the gap between the haves and have-nots.

However, when the process wealth is transferred is faulty, there’s a lose-lose situation for all stakeholders involved.

The Governments of all times have failed miserably to shore up their revenues. The situation of the State Governments is even graver.

If the highest ever allocations to MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act), subsidised loans, subsidised fertilisers, Minimum Support Price (MSP), and Fair and Remunerative Price (FRP) programmes are not solving the problems of poor farmers, the Central as well as the State Governments will have to seriously ponder on recalibrating strategies to achieve social equality.

Under such a situation, instead of looking up for innovative avenues to generate revenues, the Governments have raced to pluck low-hanging fruits.

This is the latest example…

In the recent times, the tax department notified the amendments to the Section 115BBDA of the Income-Tax Act, 1961 proposed in the Finance Act 2017. The amendment was targeted at nabbing the personal trusts established by the wealthy promoters of companies who use exemptions offered under the Income-Tax Act on dividend incomes earned by trusts, under Section 10(23D). 

But, this seems to have misfired, as this has cleared the way to impose a 10% tax on dividends earned by mutual funds on their investments in shares if the dividend income exceeds Rs 10 lakh. This move will be a step-down for the mutual fund industry and the investors. After all, they will have to settle for diminished returns due to the tax outgo. The above notification will fetch only about Rs 740 crore to the exchequer, but it will shake up the confidence of millions of investors.  Around 4.6 crore investors who have investments in equity oriented funds will be affected by the recent notification.

As on date, individuals, firms and Hindu Undivided Families (HUFs) earning dividends from domestic companies in excess of Rs10 lakh in a financial year are subject to 10% taxation if their income from investments exceeds this amount. However from the next fiscal year, this tax has been extended to all assesses, except those entities specified as domestic companies.

The timing of the change in the tax treatment couldn’t have been worse. Equity-oriented funds are being promoted as a way to create long-term wealth.  Less than 10% of domestic savings are routed into equity markets through mutual funds; but over the past couple of years, retail investors have evinced interest and channelized their savings into mutual funds through Systematic Investment Plans. In the absence any meaningful social security system, many investors have started looking at equity oriented mutual funds as a way to build the retirement corpus. But, frequent policy flip-flops will shake their confidence.

The mutual fund industry body----AMFI (Association of Mutual Funds in India)----has appealed to the Finance Ministry to provide relief to retail investors. Sharing this development with the media, an AMFI official said,“We have already represented the matter to the Finance Ministry, and many favourable opinions have come in from some leading CA firms, and so we hope that the proposal to tax dividend will not come through.” 

It’s high time the Central as well as State Governments realises that there is a limit to which they can “milk a holy cow” —the middle class. They have to figure out alternative revenue resources to reduce the burden of taxes on the middle class and empower the poor sections of this country.

What should investors do?

• Since the dividends in the hands of mutual funds would be taxable, opting for the dividend, dividend re-investment, or growth option won’t make much difference. Hence, depending on their financial goals, investors should select the appropriate avenues.
• Those who are concerned about the fall in returns on account of change in the tax treatment may try to negate the impact by investing in direct plans.

But one thing is sure, that equities remain a promising asset class for long-term wealth creation and to beat the inflation bug. So, we strongly recommend not to get deterred by the potential impact if dividends are taxed.

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