T N Pandey: Stop experimenting with tax laws

TAXING MATTERS

Explaining the concept of tax on securities transactions, Finance Minister P Chidambaram said in the Budget speech: ".... I propose to abolish the tax on long-term capital gains from securities transactions altogether. Instead, I propose to levy a small tax on transactions in securities on stock exchanges. The rate will be 0.15 per cent of the value of security. Thus, a transaction involving securities valued at, say, Rs 100,000 will now bear a small tax of Rs 150. The tax will be levied on the buyer. In the case of short-term capital gains from securities, I propose to reduce the rate of tax to a flat rate of 10 per cent."

This proposal was hotly debated. The Sensex went down by more than 110 points when the relevant paragraph relating to the tax was read in Parliament by the finance minister.

Thereafter, a strike ensued, and a delegation of brokers and stock market operators met the minister. He refused to withdraw the tax, but promised reconsideration. The revised proposals were announced in Parliament on July 21, 2004.

In the subsequent discussions, it has been proposed that the revised proposals also will be examined to see whether it is worthwhile making tax laws complex merely for earning Rs 1,000 crore by way of revenue, and whether the changes announced would lead to simplification, as was highlighted when the proposal for the tax was announced.

The Explanatory Memorandum to the Finance (No. 2) Bill, 2004, concerning the tax reads thus: "Under the existing provisions of the Income Tax Act, profits or gains arising to an investor from the transfer of securities are charged to tax either as long-term capital gains or short-term capital gains, ... at the applicable rates. Long-term capital gains are taxed at 20 per cent, after adjusting for inflation by indexing the cost of acquisition. For listed securities, the taxpayer has an option to pay tax on long-term capital gains at 10 per cent but without indexation. For Foreign Institutional Investors (FIIs), the long-term capital gains and short-term capital gains are taxed at the rate of 10 per cent (without indexation) and 30 per cent, respectively. In the case of a trader in securities, however, the gains are taxed as any other normal business income ... to simplify the tax regime on securities transactions, it is proposed to levy a tax at the rate of 0.15 per cent on the value of all the transactions of purchase of securities that take place in a recognised stock exchange in India."

With the above background, the revised proposals concerning the tax on securities transactions need to be examined. Details of the new scheme are:

• There would be no tax on long-term capital gains;
• 10 per cent tax would be payable on short-term capital gains;
• Persons purchasing units will be required to pay a 0.15 per cent tax on securities transaction (15 paise in a rupee);
• There would be no securities transaction tax on debt-oriented mutual funds. For them, the old scheme of taxation of capital gains will continue, namely 10 per cent tax on long-term capital gains, and 30 per cent (maximum) for short-term capital gains.
• In delivery-based equity-related transactions, the rate of 0.15 per cent will apply. However, this will be shared between the buyer and the seller, i.e. each will be taxed at the rate of 0.075 per cent securities transaction tax, i.e. 7.5 paise on Rs 100.
• Day traders and arbitrageurs will pay a securities transaction tax of 0.015 per cent, i.e. 1.5 paise per Rs 100. Further, such traders can offset the securities transaction tax against tax on business income. Effectively, such traders will pay no securities tax.
• The securities transaction tax at 0.01 per cent (one paisa for Rs 100) will be payable in respect of derivative transactions. This tax can also be set off against tax payable on business income.
• There would be no securities tax on transactions of government securities. For such securities, the old scheme of taxation of capital gains would continue.

Obviously, the new proposals are neither simple nor revenue-yielding. To keep track of such transactions and ensure that the tax payable is correctly worked out and paid would be an uphill task.

Further, the reports appearing in newspapers indicate that the changes would mean substantially lower revenue for the government and thus, the objective of generating more money for the government through long-winded means would be frustrated.

Originally, the projection given was to get Rs 7,000 crore as revenue from this tax. The changes would mean a substantially lower revenue of Rs 1,000 crore.

The issue then is whether the complicated exercise prescribed by Chidambaram is worthwhile. The scheme, which was intended to simplify the taxation of capital gains, has ended up being highly complicated, and has laid down multiple slabs, yielding in some situations one paisa on Rs 100.

What is more surprising is that no empirical studies were made before announcing the changes about the impact of the tax and changes on different segments of taxpayers.

The proposals, as announced, may bring in some categories in the tax net, while some taxpayers who are paying more tax may end up paying less. This may lead to compensatory results, yielding less revenue or none.

The continuation of the old scheme of taxation of capital gains for some sectors requires that the existing provisions concerning the capital gains should continue, while a new chapter (Chapter VII) in the Finance Act, with 20 new sections, would find place in the relevant tax laws. Again, the issue is: Is it worthwhile?

For many years, experiments like this have made the Income Tax Act very complicated. This happens because successive finance ministers have imposed their ideas regarding income tax without any supporting figures and data.

The very fact that the proposals are rolled back/diluted shows proper homework is not done before formulating the proposals. This is harmful for any system of taxation. Unless a check is put on such practices, any talk of simplification and rationalisation looks hollow and superficial.