The Abolition of the 9% Tax Rate on Dividends Will Be a Wrong Decision

At present, as far as the incomes of individuals and the profits of organizations are concerned, incomes received in the form of dividends are taxed at a rate of 9%, which is well below the standard tax rate (Item 4 of Article 224 and Sub-item 2 of Item 3 of Article 284 of the RF Tax Code respectively). It should be noted that, while the dividend tax rate for organizations remains below the standard profits tax rate of 20% (Item 1 of Article 224 of the RF Tax Code) even after having been increased, the dividend tax rate for individuals will become equal to the standard personal income tax rate of 13% (Item 1 of Article 224 of the RF Tax Code). At the same time, the draft law envisages that the procedure for imposing tax on the dividends received by Russian organizations from foreign organizations should remain unchanged, which means that the current dividend tax rate for them will indeed be retained. Individuals will have to pay the same tax on dividends irrespective of the origin of the organization that has paid these dividends to them (Russian or foreign), while legal entities will have to pay tax on dividends at an increased rate only when their dividends are received from Russian organizations.

According to the authors of the draft law, the aim of the bill is to increase the financial resources of RF subjects by means of pumping additional tax receipts into their budgets. Their main argument is that the 9% tax rate on the dividends of individuals violates the principle of taxation universality and equality, because a considerable part of individuals' incomes is taxed at a higher rate of 13%. At the same time, the authors of the draft law offer no substantiation for the ‘necessity' to increase the tax rate on the dividends of legal persons: they simply believe that the rate should be raised in order to bring it in conformity with the dividend tax rate for individuals1.

 

In our view, it is unlikely that the 9% dividend tax rate can in any way violate the principle of taxation universality and equality. The universality of taxation means that no one may be excluded from the process of financing state expenditures (i.e. that everybody should pay the legally established taxes and levies), while the equality of taxation means that everyone is equal before the law (that is, the tax man). In practice, the equality of taxation means, among other things, that the tax rates are not to be differentiated in accordance with the type of ownership of an enterprise, the citizenship of individuals, or the place of origin of investment capital (this principle is consolidated in paragraph 2 of Item 2 of Article 3 of the RF Tax Code).

 

Bearing this in mind, it could be said that, indeed, the principle of taxation universality would have been violated if some taxpayers were to be completely exempted from dividend tax. The argument put forth by the draft law's authors - that the principle of taxation universality and equality is not observed because the bulk of the incomes of individuals is taxed at a 13% rate - cannot be considered to be acceptable because, in reality, we are speaking about different sources and types of income that may, for objective reasons, require different taxation procedures. At present, the procedure for dividend taxation is determined by the type of income, and not by the category of a taxpayer. Thus, neither the principle of taxation universality nor the principle of taxation equality is violated.

 

As far as the principle of taxation equality is concerned, it should be noted that, while pointing out that it is being violated, the authors of the draft law in their turn suggest a measure that will distort the principle of taxation equality in regard of dividends received by legal entities. As the 9% tax rate is going to be increased only when the tax is levied on the dividends received by Russian organizations from Russian organizations, it will thus be differentiated depending on the form of ownership or capital origin - which, as noted earlier, is forbidden by the law.

 

 

The substantiation note to the draft law also affirms that the 9% tax rate on personal incomes received in the form of dividends reduces the income tax yield because it conduces to the implementation of a scheme whereby wage payments will be replaced by dividend payments. According to the authors of the draft law, this situation is further aggravated by the fact that no national insurance contributions are chargeable on the sums of such dividend payments, while the amount of distributable dividends is constantly on the rise. This statement has several principal aspects which need further clarification.

 

First, dividends are distributions of profit that are paid to the participants of an organization after the organization has accounted for its payment of tax on profits of organizations. Unlike the wages of workers, dividends are not deducted from the tax base for tax on profits of organizations. This means that dividends are subject to a double taxation of income: having being taxed as the profit of the organization paying the dividends, they are taxed as the income of the dividend receiver. Therefore, the 9% tax rate cannot be considered to be a reduced rate. And in any case, this rate is not a beneficial one! Moreover, it imposes an additional tax burden on the entire amount of the relevant income. In this connection, it is unlikely that any individual in question can actually derive any benefit from the fact that their remuneration has been mover from the category of ‘wage' to that of ‘dividends'. As wage receivers, they will have to pay income tax at a 13% rate with the related insurance contributions, while as dividends receivers they will be liable to pay tax on profits of organizations at a 20% rate (when their dividends are paid by a Russian organization), and also income tax at a 9% rate.

 

The liability to pay insurance contributions on wages does not change the situation in principle. A fairly high tariff of insurance contributions - around 34% of the amount of income (without taking into account any minor temporary reductions) - is established for incomes not exceeding Rb 568,0002. Beside this tariff, there also exists а much lower one, set at 10% of income3. It is evident that, in most cases, employers will not begin to apply the remuneration system based on dividends to their ordinary workers whose are wages below the aforesaid threshold, while the effective marginal top rate of insurance contributions for high-income persons is set at a lower level. As a result, as far as high-income persons are concerned, dividends represent a much heavier tax burden than salaries.

 

Second, bearing in mind that both personal income tax and tax on profits of organizations (which is also transferred to regional budgets) are levied on dividends, it cannot reasonably be argued that the 9% tax rate on personal incomes in the form of dividends results in a lower income tax yield.

 

Third, an upward trend in dividends is not necessarily indicative of the use of certain tax minimization schemes. On the contrary, such a trend may point to a rising profitability of a given business, which thus successfully attracts investment from taxpayers; besides, it may be interpreted as a sign of its successful development. If that is true, the proposed increase in the tax rate can be understood as a ‘punishment for success'.

 

 

As dividends are connected with financial investments, the proposed increase in the tax rate can have a negative effect on the investment activity of taxpayers. Any investor takes into account the profitability of his or her investments. In this connection, the adoption of such measures, especially when carried out without adequate substantiation, will be fraught with negative economic consequences.

 

Also, the proposed tax on dividends will reduce the potential (future) value of a growing (financed) firm, which can result in its investors and owners losing interest in the firm's successful development. Thus, despite the fact that new firms do not pay tax on dividends (because they get no profit at an early stage of their development), the proposed increase in the tax rate on incomes received in the form of dividends can considerably de-stimulate the venture capital investment process4.

 

According to the authors of the draft law's estimates, as a result of the proposed increase in the tax rate on incomes received in the form of dividends the State will generate additional revenue in an amount of nearly Rb 25bn. At the same time, this measure definitely needs some further substantiation, which must be elaborated with due regard for the arguments against its adoption suggested in our overview.

 

 V.V. Gromov - Researcher of the Tax Policy Department