It is a Report on Impact of Dividend Distribution Tax (1997) and Impact of Increase in DDT (2007) on the 212 Companies of different sectors of BSE. It is contributed by Radhika Gupta, Shivi Aggarwal, Sweta Agarwal, Saket Kumar Singh and Madhusudan Partani

1. Impact of Dividend Distribution Tax (DDT) on Dividend Payout Ratio(DPR)

2. Objectives Primary To study the impact of implementation of Dividend Distribution Tax in the year 1997 on Payout Policy of Indian companies To study the impact of an increase in Dividend Distribution Tax to 15% in the year 2007 on the payout policies of Indian companies Secondary To study payout behavior of different sector over the years To study the impact of DDT on differently sized firms namely-small, medium and large

3. Methodology Data Collection 345 Companies belonging to various sectors data on Dividend Payout Ratio from the year 1995 to 2009 was collected Market Capitalization as on 24th February, 2010 was collected Classification Companies were classified on the basis of sector Small, medium and large firms were identified on the basis of Market Cap Adjustment Statistical Tools T-test

4. Scope The period of study is from the year 1995 to 2000 and from 2006 to 2009 The scope was restricted to the companies listed on the BSE The study is done for a total of 211 companies belonging to 38 different sectors Limitations Many companies which are though significant for study were ignored on the basis of non-availability of data. T-test

5. Introduction The structure and the rate of corporate tax play an important role in determining the dividend policy Dividend tax It is levied on the amount of dividend declared, distributed or paid by the company Dividend Tax considered to be Double Taxation

6. Historical Background Till the year 1958-59, an imputation system of taxation was followed in India with respect to dividends Shareholders had to pay tax on dividend at the rate applicable to them This system of single taxation on dividend was abolished in 1959-601 and dividends were taxed for the second time separately in the hands of shareholders To summarize, till 1997, dividend income was taxed in the hands of the shareholders subject to a small relief available to the small investors.

7. Introduction of Corporate Dividend Tax Main Provisions Corporate dividend tax is in addition to the corporate tax paid by the company on its profits Corporate dividend tax is payable even if no corporate tax is payable by a company or its income The tax on distributed profits so paid by the company shall be treated as the final payment of tax in respect of the amount declared, distributed or paid as dividends and no further credit, therefore, shall be claimed by the company or by any other person in respect of the amount of tax so paid

8. Review of Literature Irrelevance of Dividends In a world with no taxes, the Miller and Modigliani (1961) proposition suggests that dividend policy is irrelevant to the value of the company Relevance of Dividends The taxation policy is considered a key determinant of dividend payout in the developed countries and the dividend decision is a relevant decision

9. Payout Trend – Sector Wise Sector Composition Diagram

11. 2002- Shree cements ( 644%)

12. 2001- Recession 2002- TATA Comm- (209%)

13. Finance 1999- IFCI ( 557%) 2003- JM Financials ( 1037%) Impact of 1997- Medium and Small No Impact of 2007

14. Low Growth and Capital Expenditure 2001- One of the highest Dividend paying Sector Nestle( 118%) and Colgate Palmolive ( 219%)

15. Dividend as Passive decision 114% to 6% Fall after 2007- Increase in DDT

16. Regarded as one of the Highest Growth Industry 2006- GTL (486%), Moser Bear ( 359%) and Tech Mahindra (500%)

20. Low Growth- High Growth

21. Many Sectors Like Textiles, Agri, Diversified 1999- Century Textiles ( 1037%) and Kesoram Cements ( 1700%)

22. Empirical Findings (using T-Test)

23. Hypotheses H0: Average DPR for the years 1995, 1996 and 1997 and Average DPR for years 1998, 1999 and 2000 are same. (DPR1=DPR2) H1: Average DPR for the years 1995, 1996 and 1997 and Average DPR for years 1998, 1999 and 2000 are not same. (DPR1≠DPR2) Also, H0: Average DPR for the years 2006 and 2007 and Average DPR for years 2008 and 2009 are same. (DPR1=DPR2) H1: Average DPR for the years 2006 and 2007 and Average DPR for years 2008 and 2009 are not same. (DPR1≠DPR2) The level of Confidence is at 90%

24. For 1997(Introduction of DDT)

26. Analysis General rule: If P-value > α; Accept the null hypothesisIf P-value < α; Reject the null hypothesis For the 10 sectors we find that the P-value > α. Therefore, we accept the null hypothesis For the 2 sectors namely, “Metal and Mining” and “Finance” the P-value < α. Therefore, we reject the null hypothesis and accept the alternate hypothesis

27. The above conclusion is also corroborated by comparing the calculated T- value with the critical T- value For “Metal and Mining” the calculated value (-1.94) is outside the permissible range (-1.796 to +1.796) at significance level of 90% Similarly for, “Finance” the calculated value (-1.83) lies outside the critical range (-1.694 to +1.694)

28. For 2007(Increase in DDT to 15%)

30. Analysis For the 10 sectors we find that the P-value > α. Therefore, we accept the null hypothesis that there is no significant change in the average DPR after the introduction of dividend distribution tax. For the 2 sectors namely, “IT” and “Oil & Gas”, the P-value < α. Therefore, we reject the null hypothesis and accept the alternate hypothesis that there is significant change in the average DPR after the introduction DDT. Further verification done by comparing the calculated t-value with the critical t-value range.

31. Change in DPR of IT The Return on equity of IT sector is very high compared to other sectors. Before 2003 the profitability of the IT firms was scanty and consequently this sector was at the bottom of the list in terms of dividend payment. The average payout of the IT sector during this period was 21.53%.

32. This can be attributed two factors Firstly, the industry presented immense growth opportunities for the companies hence the managers were of opinion that they can provide the investors better returns if they plough back the earnings into business. Secondly, most firms in Industry were facing volatile earnings stream which deterred them from paying more dividends. After 2003, there was a substantial spurt in dividend payout ratios of the IT companies. Infosys Technologies, Wipro Technologies, HCL Technologies were among the highest dividend paying companies. This surge in dividend can be attributed to high profitability and subsequently high liquidity of IT companies.

33. Moreover….. IT sector is a human intensive sector and Do not require huge capital asset base like manufacturing companies for their operations. The major asset of this sector is manpower. Funds required for recruitment and retention of manpower is comparatively less than funds required for purchasing capital assets. Firms can easily release funds for payment of dividends. Thus, IT firms in India have high liquidity and it is an important determinant of dividend payout ratio. Since the profitability of the companies is also very high so even if there is year to year variability in the earnings of the firms they can easily pay huge dividends.

34. Payout Trend – Size Wise

38. The DPR is also high because of low denominator in the form of Earnings but the numerator in form of dividends is either constant or increases

39. Also there has been no impact of Introduction of DDT in the year 1997 and increase in DDT rate in the year 2007. In fact there has been increase in payout in the year 1997 and onwards

41. Low cash reserves High co-relation between Cash profits and dividends of the companies. In the year 1997, dividends taxable in the hands of companies paying them. In the year 2001, the small firms paid low dividends because of non availability of cash profits

42. Empirical Findings (using T-Test)

43. For 1997(Introduction of DDT) No influence in payout ratio of small sized companies due to introduction of DDT There has been significant influence of DDT on the Payout trend of these companies P-value of large sized and medium sized companies are less than α (0.1)

44. For 1997(Introduction of DDT)

46. For 2007(Increase in DDT to 15%) The P-value of medium sized companies is less than 0.1 (α) This entails that there was significant influence of increase in DDT to 15% on the payout trend of these companies Also there was no impact of the same on payout trend of large and small sized companies

47. For 2007(Increase in DDT to 15%) For 10 sectors where the P-value > alpha, we can say that the null hypothesis is accepted, i.e. there is no significant change in the average DPR after the introduction of dividend distribution tax But, in IT and O&G sector, we see that P-value< alpha, so we reject the null hypothesis, i.e. there is significant difference in the average DPR after the introduction DDT

48. Conclusion A shareholder would prefer his overall tax liability computed after taking all aspects into account rather than be taxed under the thumb-rule, that is, DDT One sector which is perennially cash-strapped is made to pay DDT, when, in fact, it need not pay To make the public sector pay, DDT on dividend distributed to the Government is unreasonable and illogical One of the strongest arguments in the favour of DDT is that it doesn’t let shareholders having huge stakes in the company go off without paying taxes on their incomes.

49. Though the Dividends were made taxable in the hands of companies paying the dividends, thus has no impact on the payout trend of the companies Only few sectors had the impact of the same The argument extended against DDT is that it leads to double taxation Effect on chain investment companies