Impact on sensex of scrapping double taxation of dividends

Abstract

The taxation of dividends has generated an active debate in recent months in the media. While the industry representatives have been critical of the double taxation of dividends, the Government seems to be questioning the very premise that dividends are double taxed in India. The argument that scrapping the double taxation of dividends will give the Sensex a much needed boost seems to have tilted the scales. What will be the impact of scrapping of dividend tax on Sensex? One finds that the standard valuation models of Gordon, Modiglliani, Miller et. al. suffer from too many shortcomings to be of much help in answering this question. First, many of them do not provide for differential tax rates, such as, corporate tax rate, personal tax rate on dividends and capital gains. Second, they deal with only a small number of variables at a time. And third, they implicitly assume the capital gains to the investors to be the same as the firm’s retained earnings. In this paper, we therefore answer the question by employing one of our own models, which not only includes a wide range of variables and differential tax rates, but also captures the capital gains realistically.