Differential taxing

Capital gains tax should not discriminate between assets

One Budget announcement that caused a great deal of consternation among certain stakeholder groups was the change in tax treatment of investments in debt mutual funds. Earlier, capital gains from these were treated as ordinary income if realised within the first year, and taxed at either 10 per cent without indexation or 20 per cent with indexation if realised after that. The new Finance Bill extends the differentiation period to three years, and applies a single rate of 20 per cent to gains realised after that. While the text of the Bill suggested to some that this new regime would come into force from the next fiscal year, the revenue secretary clarified in a post-Budget interaction that, in fact, it would be applicable from this year onwards; he then backtracked somewhat to imply that it may not apply to funds redeemed before the Budget. This is a very unhealthy confusion, and should have been sorted out before the Budget announcements. Investors justly fear that if they have realised gains during the current year, they will now be liable for the additional tax under the new regime. Apparently, as odious a term "retrospective" has become in the taxation context, the new government could not resist the temptation to use it - even while it stopped short of repealing the relevant amendment to the Finance Bill of 2012.

The revenue secretary's rationale was that the bulk of investments in debt mutual funds was from corporate treasuries, with individual investors accounting for a very small share. He further said that this would now level the playing field between bank deposits - the interest payments from which are fully taxed as income - and mutual funds. Both these arguments need to be questioned. On the first, notwithstanding the distribution between corporate and individual investments, there is a basic principle at stake - that is, whether changing the rules in the middle of the game is sound. In a normal Budget cycle, such an announcement would have been made in February, with the provisions of the Finance Bill coming into force from April. This would have given all affected parties time to re-allocate their portfolios in response to the changed tax scenario. A July amendment with effect from the previous April, or even immediately, does no such thing. And, ultimately, the stakeholders in corporate earnings are individuals; the distinction in this context is facetious. On the issue of the level playing field, why focus on bank deposits versus debt funds? There is patently unequal tax treatment between equity funds and debt funds - not to mention between financial and real estate investments.

A reasonable position would be to treat all capital gains the same no matter what the source. If the principle of a tax on capital gains is accepted, the government should be neutral on the source. As long as capital losses can be netted out - both on short-term and long-term transactions - there is no real basis for differentiating between asset classes. This calls for a re-examination of the entire framework for capital gains taxation, which the government should do over the next few months, in time for consideration in the 2015-16 Budget. Meanwhile, either the provision on debt funds should be withdrawn or, as an interim measure, be made applicable from the fiscal year 2015-16, by which time a more efficient and holistic framework could be in place. The principle of a capital gains tax is not being questioned - only its implementation in a way that unnecessarily discriminates between asset classes.