Exemption causes revenue loss of Rs 49,000 crore

Last year when Prime Minister (PM) Narendra Modi made a statement to the effect that the tax concessions for investors in the capital markets were used mainly by the rich, there were apprehensions around the Budget exercise about the continuity of long-term capital gains (LTCG) tax exemption for equities. The finance minister, however, spared taxpayers by not tinkering with it.
 
India’s tax regime for the capital markets is one of the most liberal. With India also ranking very low among G-20 countries on tax collection, it is believed doing away with the long-term exemption could work in the government’s favour. The revenue losses on account of LTCG tax exemption is estimated at Rs 49,000 crore annually.  
 
Several penny stocks are traded on stock exchanges. Some of these have managed to remain listed with bare minimum compliance with the regulatory requirements. These stocks are often used for tax evasion through price manipulation.
 
In August, the Securities and Exchange Board of India (Sebi) identified several companies suspected of being shell companies and directed stock exchanges to restrict trading in these. It was suspected that investors in these companies were influencing their share prices and claiming tax exemption by selling these after a year (Indian tax laws exempt gains on sale of equities if held for over 12 months).
 
Further, in India, the securities transaction tax (STT) is a major contributor to increasing the cost of trading in capital markets. STT was introduced along with the exemption on LTCG. However, an investor ends up paying STT irrespective of whether he makes a profit or not in an investment. When investors have to pay tax on an investment on which they have lost money, it does pinch. Hence, tax, albeit at a lower rate than the normal tax rate of 15 per cent on short-term gains, appears to be a better substitute to STT. In any case, parity of STT rates across the cash and derivatives segment is also needed to improve the ratio of volumes across the two segments, which are skewed compared to global benchmarks.
 
While STT is a much simpler levy to administer compared to complex capital gains tax provisions and collection mechanisms, in the larger interest of a healthy capital market a measure to curb tax evasion can be justified.
 
Alternatively, fine-tuning the provision, like increasing the holding period from 12 months to 24 months, or setting a threshold for availing the exemption could be considered. This is important considering the fact taxpayers are yet to come to terms with the after effects of demonetisation and the goods and services tax (GST), and immediate withdrawal of exemption provisions may adversely impact investor sentiment, the stock markets, and the economy.

The writer is partner, tax and regulatory, PwC.  These views are personal and do not reflect the views of the organisation