Keep LTCG at 0%, but raise period to 3 years: Economist

A: This is a little bit sensitive because the market tends to get spooked by any talk of such taxation.

My argument is just on the basis of bringing some rationality in the taxation system. If you go back, long-term capital gains or gains made beyond one year – holding the stock for one year was made tax exempt back in 2004 and that time the logic was that we had to bring it on parity with the tax exemption given to investors who come through the Mauritius route.

Now as you know that the Mauritius Treaty was amended earlier this year to end that anomaly. So, we have to re-visit this whole logic of bringing domestic investors on par that is argument number one. Second, if you look at global practices, the long-term capital gains taxed at 15 percent for example in the US and short-term gains are taxed as regular business income. We are giving long-term capital gains at zero tax. Therefore, there is reason to examine whether we can give this zero tax status to Indian investors at a sufficiently longer duration which is three years which is what I am saying. Third reason and this is the most important reason is that India’s mix of direct and indirect tax is roughly in the ratio of 35 to 65 which is exactly the opposite of world trends. Most of our peer countries especially developed countries the ratio of direct taxes to indirect taxes is 65 to 35; which means that we need to go a substantial way to reduce this cue to correct this cue. We seem to have so many indirect taxes and goods and services tax (GST) is a very prime example right now. So indirect taxes tend to be unfair.

Prashant: You made your argument there-just two points. One, you give a figure which you say are taxes foregone by not taxing long-term capital gains in the stock market. It is a large figure and that seems to be out of whack what is commonly perceived as gains that you make from long term capital gains (LTCG). Could you tell us where that figure is coming from?

A: This is data put out by the government, by the Income Tax authorities. The last data that we have is for assessment year 2014-2015. I had said that long-term capital gains, which were tax free for that year was almost Rs 65,000 crore and I am sure it has gone up since then. So I am saying this is the large chunk of income, capital gains income. If you tax it is a direct tax, so can we afford to have such large gains go tax free that is one.

Second, I am saying that we should have long-term capital gains at zero tax, but beyond three years, which was the norm earlier anyway. In one year how can you tell whether a company is going to turnaround or give a sustained performance? You need to observe and hold stock in a company anyway for three years typically and beyond three years if you are going to make capital gains - that is going to be tax free. All I am saying is that we should seriously consider in the interest of those three reasons I gave you - can we define long-term capital gains as anything which is beyond three years? Incidentally, we also need to bring parity on the way we treat capital gains on variety of assets classes not just stocks; stocks, bonds, real estate, gold.

Ekta: So, you are recommending 15 percent LTCG? That is in line with global practices.

A: No, I said the US taxes LTCG at 15 percent. I am saying we should tax it at zero percent but keep the duration as three years; minimum holding period is three years.

Prashant: You were always part of these pre-Budget discussions. You are one of the economists who are in those consultations. Should we expect some move on this? Is the government looking at this?

A: The pre-Budget consultations are done with a variety of stakeholders and this is part of the routine exercise that the government does and the Finance Ministry does. They meet bankers, they meet agriculture people, the meet people from industry, they meet economists and we all get a chance to present our viewpoint. So, what the government does is, the final decision is obviously with the policy makers but we all get a chance to make representations as well as have a frank discussion. It is actually an interactive session. It is not only a one-way conversation, it is a two-way conversation.

Ekta: The other point that I wanted to touch upon which is not to do with the Budget but is to do with the advanced estimates which are coming out on Friday with growth. We have a lot of high-frequency indicators, plus we have the services Purchasing Managers' Index (PMI) which is indicating that maybe things are going to look a bit sluggish. Have you worked the numbers when it comes to gross domestic product (GDP), what we can expect specifically in Q3 and what the advanced estimates could be around when they are declared on Friday?

A: We have been looking at the impact of demonetisation on the Q3 and the possible impact on Q4 as well. I think we are going to see a number which is probably going to be around 6.5-6.8 percent of real GDP growth rate. As it happens, even the government estimates which are advanced estimates by the way, they are saying that they may not be able to fully capture the impact of demonetisation because a lot of data collection is still incomplete, but I do believe for the two quarters which is Q3 and Q4 of this fiscal, there will be some impact.