The reason for abolishing long term capital gains in 2004-05 was to ostensibly remove the disadvantage that domestic investors suffered vis-a-via investors coming from Mauritius.
By Latha Venkatesh
Every year the issue of taxing long-term capital gains (LTCG) in equities surfaces before the budget; markets squirm and sulk; the government buckles and retains this tax exemption leading to a post budget rally that extolls the budget. In this column I argue that the time has come to impose this tax on economic, political and moral grounds:
1. The first argument the proponents of the tax exemption advance is that Indian equities will end up becoming uncompetitive and unattractive to foreign investors. That bluff can be easily called. The attached table indicates that only five countries don’t tax capital gains from equities - Cayman Islands, Cyprus, Mauritius, Singapore and Hong Kong. The first two have a reputation of becoming tax shelters often for tax evaders while Singapore and Hong Kong, because of their city-state nature could historically grow into international financial centres by offering tax incentives.
(Table source: Dhruva Advisors)
2. The more important deduction from the table is that for the past 25 years China has attracted record foreign flows and now, domestic flows, despite a 25% capital gains tax. So have most European countries. Clearly global investors hunt for growth and are not swayed by tax incentives alone. So if India is one of the fastest growing economies, a tax on capital gains ought not to deter genuine long only investors.
3. The reason for abolishing long term capital gains in 2004-05 was to ostensibly remove the disadvantage that domestic investors suffered vis-a-via investors coming from Mauritius. One of the under-celebrated achievements of this government is the grand fathering of this tax advantage to companies investing from Mauritius. Hence now even that fig-leaf of a reason to continue the unfair advantage to domestic equity investors goes
4. The purpose of an enlightened tax system is to collect from those who are doing well and use the money for running the country and in a poor country like ours, to ensure some distributive justice. It is not the purpose of the tax system to encourage one asset class (like equities) over others (like debt)
5. The argument that equity investors need handholding since the asset class is inherently risky doesn't wash any more. The exponential growth in systematic investment plans and in flows into equity mutual funds in 2017 prove that the retail investors into equities no longer needs any hand holding
6. A stand out feature of this NDA term has been the many sided effort made by the PM and his government to seek out tax evaders and to cast the tax net over more people who ought to be paying tax. Demonetisation, the Goods & Services Tax, linking of PAN card to Aadhar and to bank accounts were all steps to make eligible people pay taxes or at least make it difficult for them to evade. The logical next step is to tax those who are making huge profits on their investment in shares. This is not even a pro-poor ideology. It is just fair.
7. During demonetisation, relatively lower classes and in GST relatively smaller businesses have borne the pain. Any downtick in stocks post the imposition of a long term capital gains tax on shares will, if any, be borne by the rich.
8. The long term capital gains tax incidentally should not be just a tinkering of the meaning of short term to mean two years instead of one year. It should clearly be a 15% tax on capital gains accruing in one year (short term) and may be a more modest 5% or 10% on all capital gains made on sale of shares over one year (long term). Any tinkering of the definition of short term will create uncertainty and not resolve the moral issue that a whole class of investors who are habitually making a lot of money are being kept out of the tax bracket.
9. Indirect taxes are regressive because they apply equally to rich and poor. Direct taxes are progressive since they tax those who are making more money. Most developed countries have a 1:1 ratio of direct to indirect taxes. In India, calculating centre and state taxes (pre-GST) indirect tax collections are nearly three times the amounts collected in direct taxes. This is unfair in any country; and almost immoral in a poor country.10. A lot of traders when confronted with these arguments agree that long-term capital gains on shares may be taxed, but insist that this should come in place of the current securities transaction tax. One fails to see the reason. Why can't both co-exist with investors allowed to set-off the STT against their capital gains?The Great Diwali Discount!
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