One of his main defences is that for a bootstrapped firm that doesn’t want to sell shares to outside investors, receiving high salaries is one of the most flexible ways for founders to take liquidity out
The board of Zerodha Broking Ltd has passed a resolution to pay up to ₹100 crore in salary to three directors. The move has led to much chatter, causing the firm’s founder Nithin Kamath to clarify matters on Twitter. In a nutshell, one of his main defences is that for a bootstrapped firm that doesn’t want to sell shares to outside investors, receiving high salaries is one of the most flexible ways for founders to take liquidity out.
Another option is to receive dividend, although from a taxation perspective, this is now the most inefficient way for a promoter to take out liquidity. The profits generated by Kamath’s firm will be first subject to corporation tax of around 25%. The remainder, if paid out as dividend, will be subject to tax in the hands of the promoters at the rate of around 36%.
All put together, about 52% of the firm’s income would be paid as taxes. One way to reduce the tax burden is to take a higher salary income from the firm, which will be taxed at a lower rate of 42.7%. From a tax perspective, things would have been much simpler for Kamath and his co-directors if they were willing to sell a marginal stake in the firm. After all, capital gains tax is much lower, at 28.5% for unlisted shares, before accounting for indexation benefits. This is the route startup founders typically take—earlier this year, for instance, Deepinder Goyal sold a fraction of his holding in Zomato and raised ₹238 crore from outside investors. Zerodha’s founders, however, are resolute about being a privately held firm, with no plans of even issuing non-voting shares at this point. They could still consider a buyback of shares, where the tax incidence is relatively lower compared to dividend income.
Importantly, all of this highlights the anomalies in India’s tax policies. Nearly two decades ago, the Vijay Kelkar task force on direct taxes had recommended bringing taxation on dividend and capital gains on par. “A differential treatment of income from dividend/interest and capital gains introduces opportunities for distorted arbitrage arising between different maturities and different coupons and also leads to window dressing opportunities for tax purposes. Ideally, total return should form the basis for taxation," the committee’s report had said, recommending the abolition of taxes on both dividend and capital gains receipts.
But rather than bring uniformity, nearly all of the government’s budgets introduce new arbitrage opportunities. “There are all forms of structuring that take place in some Indian firms to pass off salary income as capital gains income, simply because of the current tax anomaly," says a professor of finance, requesting anonymity. A uniform policy would have enabled Zerodha’s promoters to take out liquidity by receiving dividend and avoid the negative publicity of receiving unusually high salaries. But when seen in the backdrop of adverse tax implications of receiving dividend, the news doesn’t so much reflect poorly on Zerodha’s remuneration policies, as it does on India’s tax policies.