No need to raise capital gains tax for now

To be clear the IMF paper quoted in the survey is with reference to policy measures to mitigate inequality caused by possible large-scale displacement of labour resulting widespread adoption of AI. There is no direct correlation between its conclusions appearing in the Survey, and the possibility of higher capital gains tax in Tuesday’s budget which appear to be the stuff of Indian investors’ nightmare.

Nonetheless, the upcoming budget should leave rates unchanged.

While as a theoretical proposition higher rates may be sound economics -- the theory in question being that income from sale of shares and mutual funds should be treated the same as salaries -- the government should hold its hand at this stage of the development of Indian stock markets and the economy.

There are two reasons not to impose capital gains tax on equity instruments. One is that China, with which we are in direct tax for investment, has a 20% tax on all kinds of capital gains, though for certain types of share transfer the tax is not levied, as per information in the public domain.

Further, taxing capital gains in India at the highest marginal income tax rate could mean a taxation at a 39% rate, one of the highest in the world.

The income tax rate for those earning more than Rs 5 crore is 39% if the taxpayer in question was filing taxes under the old tax regime, while the rate is around 42% for those opting for the old regime.

As per PwC, Hong Kong -- whose market capitalization briefly fell behind India last year -- does not tax capital gains from sales of equity.

It is true that many countries tax capital gains at the income tax rate applicable to that taxpayer, but India's tax rate, at 35% for Rs 1 crore and above and around 40% for Rs 5 crore and more, is on the higher side.

International competitiveness apart, there can be little doubt that the rise in markets and the consequent wealth effect has substantially benefited the incumbent government in terms of boost in sentiment.

Further, the wealth effect boosts consumption as a rise in value of equity and mutual fund holdings encourage buying. This may reinforce the premiumisation of consumer spending widely referred to by FMCG companies, but till there is a structural solution to the problems of rural underemployment, we may have to live with a faster growth in consumption of relatively pricier goods.

Also, the huge rise in SIP inflows since 21-22 have created a large category of people, many of them new investors, who have benefited from stock market investments.  SIP inflows were Rs 21,260 crore in June 2024 compared with Rs 8,183 crore in May 2019.

Remarkably the amount collected in June 2024, is about half the amount the during the whole of fiscal 2016-17. The number of SIP accounts were 8.99 crore (89 million) more than four times the June 2019 number as per AMFI data. A sudden rise in capital gains tax would hurt the confidence of these investors.

Further while foreign portfolio investors may be protected under various tax treaties, clearly domestic investors would have no such protection.

A drastic alteration of the capital gains tax regime should be off the table, at least for now.