If Long-Term Capital Gains Tax On Listed Equity Were To Return...

Should a tax on long-term capital gains on equity be levied? Here’s what the experts have to say.

Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)
Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

For almost 13 years now, the issue of reinstating the long-term capital gains tax on listed equity shares pops up with unerring accuracy weeks before the Union Budget presentation. This year is no exception.

This time the rumour returned on the strength of a reported proposal by BSE Ltd. that the tax be reintroduced. Capital market and tax experts are divided on whether the tax ought to make a comeback.

If Long-Term Capital Gains Tax On Listed Equity Were To Return...

There is a case for some sort of “concessional rate” on long-term capital gains, Ketan Dalal, managing partner at tax consulting firm Katalyst Advisors, told BloombergQuint. Dalal argued in favour of the re-imposition of the tax on “equitable tax burden” grounds, referring to income inequality and the need for a wider tax base.

But maybe an exception could be made for small investors, he conceded.

If LTCG Tax Were To Return...

If LTCG on listed equities were to return, Securities Transaction Tax should be abolished said Pranav Sayta, tax partner at EY. Sayta argued that the exemption should continue in the interest of tax predictability and stability. He said setting-off STT against LTCG tax wouldn’t work in a year of losses.

Instead of reintroducing the tax, Sayta suggested that the definition of ‘long-term’ - in this instance one year - be extended to two or three years.

“One year is too sweet a period to determine long-term,” he said, adding that the rationale behind determining a different “long-term” for different asset classes is beyond him.

Philosophically, I don’t quite understand why for listed shares, long-term is defined in terms of sale after one year, for unlisted shares, long-term is sale after two years and for any other asset, long-term is sale after three years...that logic seems to beat me.
Pranav Sayta, Tax Partner, EY

Dalal pointed out that in the event of a levy of LTCG tax on listed equities, an interest deduction should be available to those who may have borrowed money to purchase shares.

But both tax experts agreed that in the absence of data on revenue foregone on account of the LTCG exemption it was tough to make a clear case for or against the return of the tax.

The Union Budget 2016-17 estimated Rs 7,767 crore in STT collections.

Meanwhile, income tax data for the fiscal year 2014-15 shows that total long-term capital gains across companies, firms, and individuals, amounted to Rs 84,847 crore. But this likely includes LTCG on equity and other asset classes such as real estate.

The other argument in favour of reimposing LTCG tax on listed equities goes towards helping correct India’s tax skew towards indirect taxes.

From a tax-to-GDP ratio of 3.3 percent for direct tax and 10.73 percent for indirect tax in 2000-01, India has taken 18 years to improve to 5.79 percent and 10.55 percent respectively.

The Return Rumour

Back in 2004, while presenting the Union Budget 2004-05, the then Finance Minister P Chidambaram had abolished LTCG tax on listed equities i.e. gains arising from sale on a stock exchange of equity shares held for more than a year.

In December 2016, none other than Prime Minister Narendra Modi help restart the rumour when he mentioned it at an event hosted by the Securities Exchange Board of India.

For various reasons, the contribution of tax from those who make money on the markets has been low.... To some extent, the low contribution of taxes may also be due to the structure of our tax laws. Low or zero tax rate is given to certain types of financial income. We should consider methods for increasing it in a fair, efficient and transparent way.
Narendra Modi, Prime Minister (Dec. 24, 2016)

However, Finance Minister Arun Jaitley didn’t address this in the union budget.

Watch the full conversation here:

Here’s the edited transcript of the interaction.

Do you think tax should come back?

Pranav Sayta: I don’t think so. This regime has stood the test of time. The government introduced it with a very clear ideology of trying to have security transaction tax continued for so many years. There is simplicity to it. There is a certain element of tax without, whether there is profit or loss and this has stood the test for a long time. That said, I think it should be continued. Stability, predictability, lack of uncertainty is a big thing from a tax standpoint. I think that this uncertainty should put to an end. One should either take a stand one way or the other, but I would think in favor of stability and in favor of STT versus long term capital gains tax is what they should go with.

Do you think it is debate between STT and long-term capital gains tax?

Ketan Dalal: I understand the stability part but I think there is a case from an equity standpoint. There is a case for some kind of concessional rate on long term capital gains. It may not be the full rate, but it should be some kind of concessional rate. Also, we have to look at it from a larger perspective, that is the other rates should be brought down. You cannot have a long term capital gains and the rates which have been promised to be brought down for a long time. We currently have them at 35 percent. We had those rates at 31 percent in 2010. Eight years later, the rates have gone up because surcharges have gone up. But on the long term capital gains, I think there is a case to bring it there. For example, China has 20 percent. Maybe what we can do is to have smaller investors exempt, given the fact that there is a lower equity penetration from smaller investors. Like, somebody who make gains of Rs 2-3 lakh a year on long term capital gains will be exempt because that will also encourage and incentivise the equity penetration. But over and above that, I think there a case to bring it back.

Do you think the smaller guy should be exempt from it?

Sayta: There are merits to a long term capital gains tax and one of the merits is bringing down inequalities of income. I am not sure how much long term capital gains tax will contribute to that particular kitty. I assume that long term capital gains tax does come and it will mean repeal of the STT because otherwise it will be a double wham. I am not too sure of a set off because if I suffer a loss I still pay STT and if I don’t make a gain, I still pay STT. There is different gain for different year. I am trying to complicate the tax even more and I am not too sure that is going to achieve much purpose because at the end of the day, we are talking of two alternative tax regime. Either a tax on total sale price or purchase price as the case maybe once in for all, no questions asked, simple, stable and it has continued for so many years. I don’t need to maintain details of my cost, year and date of acquisition. It saves so much time from a tax payers end point and so much time from a tax administration standpoint. I am not too sure that the analysis is done on how much they are going to collect from capital gains.

This is a never ending game. Markets might go up and down. But the Rs 84,847 crore calculation is the maximum upper cap because there is a lot of capital gain. It may be by unlisted share sales, other assets other than shares, etc. So, there is lots contained in it. There is undoubtedly a case from an equity standpoint. Someone who earns a lot of long term capital gains can’t be expected to go scot-free versus the person who is slogging his way and earning salary income and pays all that tax. There is a big sentimental issue too that why should I be paying tax when long term capital gains are tax-free. But the point is, from government standpoint, how much are they losing and is the effort and putting the tax payers through that pain really worth it.

The potential gain in 2014-15 on account of LTCG would have been around Rs 8,000 crore, if all of the LTCG was equity oriented and STT collects about Rs 7,700 crore.

Dalal: In reality, today we have the market at alomst 35,000 in BSE Sensex and its at an all time high. We don’t know whether people will make gains or not. Also, if you have to pay the tax many people prefer to hold on. So, it is very difficult. I am not on calculation although I suspect that it will logically higher than Rs 7,500 crores, given the fact that we have prices of stocks at the place where they are. But I am on more of a general principal that there is some case to tax it. Maybe at some concessional rate or may be the smaller guy who pays 20 percent tax rate could be exempt or may be a combination of quantum of gain and a particular tax rate that he will tax at the lower one and as you go up the value changes and you may pay higher taxes or the maximum cap could be 10-12.5 as short term is 15. You never know they may get short term to 20 and this to 12.5, but just as a manner of concept.

Sayta: Irrespective of what the decision is, it should not be based on where the markets are based where they are which is unfair. When there are losses suffered under market you continue with STT. Suddenly when the markets are looking good, you want to bring is, that philosophically, I am against it. If you want to bring in Capital gains tax and substitute it with STT, then its fine. Let it be stable thereafter. It can’t be that markets are doing well, you levy LTCG tax. I think that should not be the dictating or determining factor. It should be the philosophical view to carry whether STT is appropriate form of taxation, it has virtues of simplicity and stability or you want the capital gains tax. But the trigger should not be where the markets today are.