We had a productive trip to India this month, meeting the management and directors of our portfolio companies, their operating subsidiaries, sell-side analysts, journalists and investors.

A frequent topic of conversation was the upcoming abolition of Dividend Distribution Tax (DDT), which is significant for holding companies.

Under the current system, DDT is paid by the companies paying dividends, rather than by the recipients. To avoid double taxation for inter-corporate dividends, holding companies can net off dividends received from dividends payable before calculating DDT. However this only applies to dividends received from subsidiaries and not from affiliates or other investments. It also cannot be used by companies at the intermediate level in holding company structures.

From 1 April – assuming the proposed changes go into effect as scheduled – dividends will instead be taxed in the hands of the recipient as regular income, at the recipient’s applicable tax rate. At the same time, the deduction for subsidiaries will be extended to affiliates and equity investments, as well as to companies at all levels of the corporate structure.

The implication is that, from April, holding companies which receive dividends will have to pay them out to avoid being taxed. By itself this should prompt many holding companies to start paying out dividends (most such companies have zero payouts), as it will cause destruction of value otherwise.

The counter-argument we have heard is that, since major shareholders (or “promoters”) tend to be in the high-income bracket, they will not want their investee companies to start paying dividends as they will not want to pay a 40%+ marginal rate of tax on this income.

But for companies to listen only to their promoters and ignore the wishes of low-income retail investors, domestic mutual funds, foreign investors, and anyone else with a lower marginal tax rate is clearly favouritism and is behaviour that has been the target of enforcement actions by the stock market regulator SEBI in the past.

The removal of DDT thus gives investors an additional point of leverage when pressing companies to raise their payouts to shareholders.

We don’t think this point is yet commonly appreciated by the companies or by the market. During our trip we met several company executives that were unaware of the upcoming changes.