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Taxing Long-Term Capital Gains: Opportunism Wrapped In Principle

Budget 2018 puts the government’s actions in conflict with its intentions and objectives, writes Bobby Parikh.

Pedestrians walk past the Bombay Stock Exchange building in Mumbai, India, on Feb. 1, 2018. (Photographer: Dhiraj Singh/Bloomberg)
Pedestrians walk past the Bombay Stock Exchange building in Mumbai, India, on Feb. 1, 2018. (Photographer: Dhiraj Singh/Bloomberg)

“Will he?” “Won’t he?” “Should he?” After weeks of speculation and conjecture, we now have an answer. He has. And in doing so, has ensured that the hoary tradition of subordinating principles to opportunism, making short shrift of consistency, and inflicting further provisos and overriding clauses to a tax law that is creaking with these, continues unabated.

P Chidambaram introduced the tax exemption for long-term capital gains on listed equity shares in his July 2004 Budget noting that “Capital gains tax is another vexed issue. When applied to capital market transactions, the issue becomes more complex. Questions have been raised about the definitions of long-term and short-term, and the differential tax treatment meted to the two kinds of gains. There are no easy answers, but I have decided to make a beginning by revamping taxes on securities transactions… 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… In the case of short-term capital gains from securities, I propose to reduce the rate of tax to a flat rate of 10 percent. My calculation shows that the new tax regime will be a win-win situation for all concerned.”

This position has held steady since, although the capital gains tax provisions underwent a number of other mutations in the intervening years. The first signs of a possible rethink came in December 2016. In a speech at a SEBI-organised event, Prime Minister Narendra Modi observed that “those who profit from financial markets must make a fair contribution to nation-building through taxes. For various reasons, the contribution of tax from those who make money on the markets has been low… I call upon you to think about the contribution of market participants to the exchequer. We should consider methods for increasing it in a fair, efficient and transparent way.”

Clearly, what was a ‘win-win’ situation in 2004 was no longer so in 2016.

Cut to the present. While the salvo for change was fired in late 2016, the amendment has come through in 2018. Look what Finance Minister Arun Jaitley had to say by way of explanation: “…the equity market has become buoyant… This has also created a bias against manufacturing, leading to more business surpluses being invested in financial assets.” Really!

Economic Affairs Secretary, Subhash Garg had a slightly different take, noting that “it was introduced because there should not be any asset class which does not suffer any taxation while all other classes suffer. The equities have given good returns so they should also contribute.” Opportunism wrapped in principle.

Finance Secretary Hasmukh Adhia had this to say: “This is a gain which is not accruing from any effort but is just an investment gain. It is only reasonable that we look to get some revenue from this class of income.” Easy money must be taxed.

Secretary Adhia further clarified that Securities Transaction Tax would continue to be levied even after capital gains tax is introduced for the reason that “…the long-term capital gains tax, even at 10 percent is half of what it is for other assets particularly the immobile property so it is a very sweet deal which has already been given to the equity market. Secondly, our total income from STT is only Rs 9,000 crore and that is nothing actually compared to the gain of Rs 3,67,000 crore made from long-term capital gain [that] has been reported. Now compared to that kind of a gain what we are taxing even by way of STT is only Rs 9,000 crore so both this will co-exist now….”

Easy money must be taxed in every which way it can.

By reducing after-tax returns, the tax imposition will raise investment return thresholds for foreign portfolio investors as well as private equity investors. India will also become one of few emerging markets in Asia to tax capital gains, potentially placing it at a competitive disadvantage for attracting foreign portfolio flows, all other things being equal. For all investors, whether resident or non-resident, the tax-exempt status of such gains reduced the points of dispute with the revenue authorities; a tax, howsoever modest, will potentially reverse the benefits that have accrued going forward. Time will tell how this may impact the trend of growing savings financialisation that we have been witnessing.

A five percent rate difference between tax on long-term gains and short-term gains may not be material enough to drive behaviour to invest for the ‘long’ term.

It would therefore not be unreasonable to expect that the holding period for ‘long-term’ characterisation could be extended from 12 months to 24 months (after all, extending Secretary Garg’s rationale, why should different asset classes have different holding duration to qualify as long-term assets) or for the tax rate on short-term capital gains to be increased.

Beyond everything, however, the continual tinkering with tax provisions perpetuates complexity, and materially undermines predictability, transparency and stability, all oft repeated objectives of the government in relation to tax laws. Over the past 20 years, provisions in relation to taxation of capital gains would have undergone over 20 changes — duration of holding for different categories of assets, rates of tax applicable to non-residents, to residents and to foreign portfolio investors, rules relating to method of computation of taxable gains, rules for set-off and carry forward of capital losses, tax treaty modifications and the interplay of tax treaties with the Indian General Anti-Avoidance Rule, Minimum Alternate Tax provisions, applicability as well as rates of STT. Although difficult to quantify, there is an economic value to predictability and consistency. This is what the government desires for its taxpayers as evidenced by the government’s repeated averments to this effect, and its desire to end ‘tax terrorism’. That government actions are in conflict with its intentions and objectives is distressing.

Bobby Parikh is Managing Partner, Bobby Parikh Associates.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.