By Tushar Pradhan, Director at Hxgon Partners LLP
The first full budget of the third term of the BJP government and the first of the coalition government is the subject of much debate already. There are various wishlists that industry bodies, corporates and individuals have prepared and are keenly looking at the fine print at the incoming budget. While it is a full budget, as opposed to an interim budget going into the elections in February, it will also be pertinent to note that in view of only a part of the year now being covered the government may decide to keep the policy oriented and major announcements for next February.
Having said that, certain headlines point to some very sensitive issues especially connected to the capital markets, that have grabbed attention lately. While much of the speculation should rightfully border around the overall growth orientation, revenue maximisation and social equity addressed in the budget as main thrusts, the more controversial issue is the one relating to capital gains tax. There is speculation that there may be a change in the rate, or the holding period to determine short or long term for investments in equity and equity related instruments. Such a change if enacted may have an outsized impact on the market as sentiment in the short term is more impactful than the actual outcome.
Also read: Economic Survey pegs FY25 GDP growth at 6.5-7%
It will be interesting to note the reason why differential tax rates exists between income tax rates and capital gains tax in the first place. In a country that was starved of investment from its own public, the challenge was for providing capital for its growing industrial infrastructure needs by way of incentivising longer term investments by providing a tax arbitrage. If investors are willing to put their savings to work for a longer term, they should be adequately compensated for such allocation that not only satisfies the need for capital formation without additional outlay by the government or its agencies but also provides for a healthy return for deferring the outcome to investors. The capital gains tax globally also follows a similar pattern. For example, in the US, the long-term capital gains tax rates for the 2023 and 2024 tax years are 0%, 15%, or 20% of the profit, depending on the income of the filer. Please note, lower income filers get the benefit of zero capital gains tax there.
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This debate that these tax rates confer some undeserved advantage to investors while the employed majority is paying a higher tax rate is erroneous. The twin advantages of capital formation, employment of private capital for longer term usage is a needed measure for the government to see a lighter load on itself to provide the same. The short-term capital gains tax also is set higher to discourage speculation. Having increased the LTCG from zero to 10 percent and introducing differential rates for debt mutual funds and elongating the term for defining such gains, the government has already done its bit to disincentivise such investments to a certain degree. To change this picture for the worse will be sheer folly.
This kind of signaling will sour investor sentiment and the booming equity cult that has recently formed will thus die a premature death. India needs long term investments, and such investments need the support of the government. Investments are not without risk and the just reward for patience is by way of such differential rates and in the larger interest should remain as status quo. After all, don’t fix it if it ain’t broke!
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