16. Taxation of Income from Interest, Dividends and Capital Gains

Interest earnings and dividends earned are comparable for tax purposes in that the taxation of interest and dividends is usually viewed as taxing nothing other than ordinary income. Dividends and interest on selected types of savings may be taxed less than individual income to encourage capital investment and savings. However, such incentives cause inefficiencies by encouraging taxpayers to invest and save in lower-taxed segments that could effectively favour higher-income taxpayers since they tend to have higher capital income. On the payments side, interest payments may be fully or partially deductible, while dividends paid out may be partly deductible or may not be recognized in the calculation of taxable profits. Tax treatment of earnings that are retained by businesses and do not comprise dividend payments are usually treated differently for tax purposes. Selected country experiences are illustrative. Taxing capital gains is subject to greater debate and discussion. It is a complex area of income tax design; hence some countries choose to tax it in a scheduler manner, that is independently of the regular income tax schedule. Its rationale, concept and design structure deserve particular attention. These perspectives on the taxation of interest, dividends and capital gains are examined in this chapter.