Cushioning the blow

Taxation regime for capital gains from equities needs a relook

The Union government is reportedly planning to tweak the tax norms for gains from equities in this year’s Budget. This is a sensible move as the time has come for taking a relook at the present system of an individual not being required to pay any tax on gains from equities if the shares are held for a period of more than a year. Though this demand emerged from several quarters in the run-up to some earlier Budgets as well, the government has been ignoring it on the grounds that a differential tax treatment is required in order to encourage long-term investments instead of short-term trading in the capital market.
 

But this argument of Indian households needing some special allurements to invest in equity is a fallacious one as there is no reason why equity investments alone should continue to enjoy star billing among investments in bonds, real estate and gold, where the asset is considered held for the long term only if not sold for three years. There is another reason for taking a relook at the capital gains tax for equities. Recently, the Securities and Exchange Board of India (Sebi) barred 240 entities and individuals for making illicit gains through long-term capital gains tax benefits.

It is possible that the imposition of the LTCG tax on equity could cause some dismay among investors. Quite apart from high net-worth individuals, there is a significant middle-class presence in equity mutual funds. Households own around 48 per cent of assets under management at equity mutual funds — that is almost half the total AUM of Rs 8 trillion. Individuals own at least that much again in direct equity holdings. However, it is also a fact that long-term and short-term gains from equity are taxed in most jurisdictions. The current treatment in India clearly discriminates in favour of equity, compared to other assets, which also carry risks.

The other argument for the abolition of the LTCG tax benefits is that it would be a rational and effective way to generate additional revenue at a time when the fiscal situation is not healthy on account of lower collections from the goods and services tax even as economic growth has not rebounded as fast as expected. Meanwhile, crude oil prices have started to trend up, inflating the subsidy outgo. Hence, exploring new revenue streams is an imperative while not upsetting investor sentiment much.

Several alternatives, being suggested in many quarters, deserve consideration for cushioning the impact on investors. For example, tax short-term capital gains on the stock market at the applicable income tax rate for the individual concerned (as in real estate), instead of 15 per cent as now. Simultaneously extend the holding period for qualifying as long-term from the present one year to two or three years (as for some kinds of debt and for real estate). That way the government earns revenue from short-term capital gains but leaves long-term gains untaxed. It may also be possible to reduce, or eliminate, the securities transaction tax (STT) as a quid pro quo. The holding period for the LTCG tax could also be extended to three years with inflation indexation, to align it with other assets. The tax rate might also be very moderate, say, 3 per cent, with gradual escalation planned. Even if a moderate rate is imposed, it could raise hundreds of billions while rationalising the tax structure to boot.