Capital gains: Why the change in long-term time frame is retrograde

Increasing the minimum holding period from one year to three, may drive foreign investors away from the Indian equity market

In a move that is likely to impact the already beleagured stock markets further, the government is considering tinkering with the definition of long-term capital gains on stocks. Reports say that it is mulling the idea of increasing the minimum holding period of equity shares in order to qualify as long-term capital gains, from one year to three years. Currently, there is no tax on long-term capital gains on shares.

Investor bodies and brokers have been making representations to the government to bring down short-term tax rates and remove securities transaction tax (STT) on trading -- steps that will attract investments into the financial market. The government’s line of thinking seems to be quite contrary as it seeks to increase the tax burden on investors.

At present, an investment held for a period of one year or more is considered long-term. This period of one year might be changed to three years. This means that an investor will have to hold on to his investment for a minimum period of three years in order to avoid paying 17 per cent as tax (short-term capital gains tax plus surcharge).

In a scenario where companies' fortunes are changing in one or two quarters and business cycles are becoming shorter with increasing competition and changing consumer preferences, a three-year holding period imposed investments is too long.

Currently, investments in unlisted companies are taxed on short-term basis if they are held for a period of less than three years. There is a pending demand from private equity players to reduce this period to one year.

Equating listed and unlisted investments is wrong simply because in the unlisted space, the investors generally are informed buyers with an open channel of information flow between the company management and investors. This is not the case in listed entities, where many companies do not even talk to analysts or media. Further, there is no transparency in valuations of unlisted companies. Private equity funds and investors normally have a mandate to hold on to the investment for a longer period of time, usually seven years.

Investment in equities, especially by retail investors, is sensitive to changes in the tax regime. With rising volatility, many would not like to keep their exposures open for such a long period. More than retail investors, foreign investors, whom the government is trying to woo, will be wary of investing in a country where regimes change and so does taxation. However, they have a way out -- they can exploit the window of tax havens to route their investments.

Industry experts, however, feel that it would be difficult to bring in the changes -- if not for anything else than the fact that the numbers do not add up. In an interview with CNBC, Dinesh Kanabar, CEO of Dhruva Advisors, said that government will have to forego around Rs 7,500 crore of tax that it collects in the form of STT, in order to increase the period for long-term capital gains. In the current environment, few investors are actually sitting on profits.

Further, as Gautam Mehra, Leader, Tax and Regulatory, PwC India points out, with the advent of GAAR (general anti-avoidance rule) and developments around BEPS (Base erosion and profit shifting), it may get more difficult for foreign investors to qualify for treaty protection against such capital gains tax. BEPS is a global framework that India will be plugging into from April 2016.

The only question that the policy makers need to ask before bringing in changes in the tax regime is whether the new policies will attract investment, mainly foreign, in the short and long term or dissuade investors from moving to other markets. The government needs all the resources it can garner in order to realise its dream of ‘Make in India’ and set up much-needed infrastructure in the country. In order to attract investments, it will have to dangle the carrot rather than showcase the stick, which seems to be the current thinking.