The Union budget for FY24 to be presented on February 1, 2023 will likely be the last full budget before the 2024 general elections. Obviously, the expectations from this budget are high. All stakeholders -- industries, traders, savers, investors, consumers, farmers, professionals, etc -- are representing the finance minister to consider a variety of incentives and/or a favourable tax regime for them.
In the context of capital markets also, a favourable tax regime and incentives to promote investments have probably been the most consistent demand. In particular, in recent years, taxation of long-term capital gains (LTCG) and dividends dominated the pre-budget discussions and speculation. This year it has assumed more significance as government officials have hinted at the rationalisation of the provisions relating to the taxation of capital gains.
In my view, the government must take this opportunity to define a conceptual framework for the taxation of capital gains, dividends and capital market transactions and provide incentives for investments in financial assets. Apparently, the process has so far been random and discretionary.
The government may consider defining “assuming risk” and “significant contribution to the Indian economy” as prerequisites for allowing fiscal incentives and tax concessions. Tax concessions and fiscal incentives may be extended to an investor only if both conditions are met. Investors who assume significant risk to help the private sector add significant capacity that would contribute positively to the overall economic growth, development and stability may only be rewarded with tax concessions and/or fiscal incentives.
Reward Risk-taking
Subscribers to an initial public offer (IPO) of equity shares of a new business assume material risk and provide risk capital to the entrepreneurs. These investors may be allowed full capital gain tax exemption on the sale of the shares so acquired. However, subscribers to an “offer for sale” by a 50-year-old profit-making public sector undertaking offering a 3-4 percent dividend yield, neither assume significant risk nor provide any risk capital to the undertaking. Such investments ought not to be given tax incentives.
Similarly, buying a stock in the secondary market does not provide any direct advantage to the underlying company. In fact, in such a case, the seller transfers his risk to the buyer. Offering a concessional rate of tax on capital gains made by such sellers defies logic in the present scenario. It may have been relevant when the Indian capital markets were at a nascent stage and we needed to encourage larger participation. What could be considered is a lower cost of transaction for the buyer who is assuming risk from the seller. The buyer may be exempted from the securities transaction tax (STT) and stamp duty.
Empirical evidence indicates that holding securities for a longer term materially enhances the returns to the investors; and hence minimises the risk. Besides, there is little evidence to suggest that holding a listed stock for more than one year or three years in any way helps the economy or the capital markets.
One could appreciate the "development of capital market and growth of the economy" argument in the case of investing in new IPOs, PE funds, or venture funds, as in such cases businesses get the much-needed risk capital. But the secondary market transactions do not pass this muster. There is little evidence to show that incentives for a longer-term holding period improve market liquidity or reduce market volatility.
In fact, it is common knowledge that the LTCG exemption for tax has been abundantly misused for the purpose of money laundering. In the past few years, the regulator and taxation authorities have also initiated action in many cases for misuse of LTCG taxation provisions for money laundering.
Overhaul LTCG Tax
- The finance minister may consider “assuming risk” and “significant contribution to the economy” as prerequisites for any investment-related incentive and/or tax concession.
- Subscribers to initial public offers of new businesses, pre-IPO investors, venture capitalists, angel investors and other such investors who assume significant risk and provide risk capital to entrepreneurs may be provided full exemption from the tax on capital gains arising from the sale of shares so acquired on a recognised stock exchange, regardless of the period of their holding.
- The investors who provide unsecured deposits to the companies, to meet their working capital and other requirements assume significant risk and are an important source of funding for the corporates. It may be considered to reward these depositors by taxing interest on unsecured corporate deposits at a lower rate.
- Similar treatment may also be considered for subscribers to non-convertible debentures also.
- The day traders, jobbers and market makers provide material liquidity to the capital markets and help in containing the impact cost of trades. They, therefore, aid risk-taking. These traders and market makers may be incentivised by exemption from STT.
For the taxation of capital gains arising on the sale of non-financial assets like real estate, art and jewellery, the same criteria of “assumption of risk” and “significant contribution to the Indian economy” may be used for allowing incentives and concessions.
Vijay Kumar Gaba is Director, Equal India Foundation. Views are personal, and do not represent the stand of this publication.
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