Prior to 2004, long-term capital gains on the sale of shares were taxable. It was made taxable in the 2018 Budget with the objective of bringing more money into the tax net, bringing uniformity among tax-paying citizens and making the capital market healthier
Unlike the regular tax desk which is manned by a tax officer whose job is to levy tax on you, this desk is manned by a non-serving tax officer who wishes to share his experience of 35 years in the tax department, while, discussing tax provisions. It is advantageous to know how the tax department thinks and acts when, as said by Benjamin Franklin, “In this world nothing is certain except death and taxes”
The presentation of the Budget every year gives rise to various comments and analysis. This year too is no exception. The Budget had some good points, but it also had issues which created turmoil in the capital market. The stock market plunged by more than 800 points on the day following the Budget, which was the second biggest fall in the stock exchange on a single day.
What was the reason for such a big fall? The answer is, the proposed legislation on taxation of Long Term Capital Gains (LTCG) on the transfer of shares. Earlier, such long-term capital gains were free from tax. The share market was booming prior to the presentation of the Budget. The sentiment of investors really got hit, but the subject matter of taxation on capital gains has to be understood before reaching any conclusion.
The objective of the Income Tax Act is to levy tax on the total income of a person. Income can be from salary, business, property, capital gains and from income from other sources. Tax is levied on income from assets which may be human asset, or asset in the form of property, and accordingly various heads of income have been created under the Income Tax Act (1961). Under the head 'Capital Gains', a distinction has been made on the transfer of properties other than shares and capital gain on the sale of shares. There is further subdivision under Capital Gains between long-term assets and short-term assets. Assets held for two years or more, other than shares, is a longterm capital asset. In the case of shares, if they are held for one year or more, they become long-term capital assets. Assets held for less than the threshold limit are short-term assets. There is a further distinction between the rate of tax charged on the sale of long-term capital gains and short-term capital gains. The rate on short-term capital gains is 15% which remains the same as in the past, while the rate for longterm capital gains proposed in the Budget is 10% as against NIL earlier. However, one relief provided in the proposed legislation is that long-term capital gains on the sale of shares will remain exempt up to Rs.1 lakh of such income.
The honourable Finance Minister said that there was a sale to the extent of Rs.3,60,000 crore of long-term shares as per the Income Tax returns filed last year. No tax had been levied on this big amount. Investors, particularly highnet- worth persons, companies and FIIs gained maximum from this income. Prior to 2004, long-term capital gains on sale of shares were taxable. The same was made taxable again with the sole objective of attracting money into the capital market while making it healthier.
It was seen that many investors were using the Mauritius route to invest in the capital market to avoid tax liability as there was no tax on capital gains on the sale of shares in Mauritius. Many domestic investors were seen doing round-tripping to avail tax break through the Mauritius route. Recently, there has been an amendment in the Double Taxation Avoidance Agreement (DTAA) between India and Mauritius as per which the Mauritius route no longer remains attractive. This, along with the booming of the stock market, triggered the new proposal in the Budget.
The negative reaction of the market is not in the right perspective. The market has overlooked the attached new proposal of grandfathering of the cost of the shares, leading to long-term capital gains. The cost of the shares will be the market price of the shares as on January 31, 2018 which will help old investors reduce their tax liability. The capital market has also overlooked the fact that only five countries the Cayman Islands, Mauritius, Cyprus, Singapore and Hong Kong–do not levy tax on capital gains on the sale of shares. Singapore and Hong Kong are small city states, while the other countries are only tax havens. India, which is a rising power, does not deserve to be lumped with tax havens or with city states. The Budget is an annual financial statement of the country which estimates the needed expenditure for the country and has to source such expenditure from possible income. The tax-free Rs.3,60,000 crore on long-term capital gains on sale of shares was a low-hanging-fruit which required to be plucked to meet the ever-increasing genuine expenditure, particularly in social sectors like health and education.
∕ ∕ ∕ The objective of the Income Tax Act is to levy tax on the total income of a person. Income can be from salary, business, property, capital gains and from income from other sources. Tax is levied on income from assets which may be human asset, or asset in the form of property ∕ ∕ ∕
The exemption of tax on LTCG on the sale of shares was beyond morality or logic. A salaried person pays tax on his meagre income, while big people and big companies earn tax free income without doing any actual work. Their money beget more money without any sweat. Legislation should be fair on all sources of income; it cannot be discriminatory. The other issue was that the money was being used for earning tax-free income, and was not going into the expansion of business which would have created more jobs. The big private investors’ choice was for an easier method to earn income without any tax liability, than to start new factories and giving jobs to our youth.
There is another new proposal under Section 115-R of the Income Tax Act which has attracted controversy. This is in the context of Dividends Distribution Tax (DDT) on Mutual Funds. Earlier there was no DDT while declaring dividend against Equity Orientated Funds (EOF) as against the proposed new rate of 10%. Normally, the mutual fund route is taken by middle class investors through SIP, and hence there was a fear that the middleclass would suffer. The new proposal has been brought to bring about parity between income from LTCG and income from dividends. In the absence of the same, investment could have got skewed while making investment for earning dividends and on investment for earning capital gains. This would definitely hurt some genuine investors, but the same was unavoidable when LTCG was brought under the tax net.
There is another area of controversy and that is in the context of Security Transaction Tax (STT). STT was brought in when LTCG was made tax-free, now STT still remains while LTCG has been made taxable. STT is something like TDS against transactions in the share market. The total income earned by the government from this source is roughly around Rs.7,000 crore which is not a very big amount. Further, STT is deducted while computing income from capital gains, and thus for the investor it is not of much consequence, while for the government it continues to remain an additional source of income.
Some people have expressed the fear that in view of the new legislation on LTCG, foreign investment in the country may suffer. The fear is unfounded. It is well-known that China has been receiving huge foreign investment even when the tax on LTCG in China is 25% as against the proposed 10% in India, under the new Budget proposal. Foreign investors look for profitability while choosing a country to make investments. The economy of China is galloping, and has hence attracted big investment despite the 25% tax on LTCG. So the tax rate is not a constraint, but at best only one out of many parameters considered by investors. Now, our country too is rising fast economically and we will keep on attracting more foreign investments despite the levy of a modest tax of 10% on LTCG. In America, which is another country attracting big investment, the tax rate on LTCG on shares is 15%. These facts go to indicate that our proposed legislation is not out of context.
While analysing the Budget we must have a holistic view. The country needs more money, as still almost 30% of our population is below the poverty line. To maximise our tax revenue, new sources have to be identified. The new legislation on LTCG is an effort to earn more income and the same cannot be abandoned if it hurts some people, provided the money goes to the poor and to national development. To quote Hillary Clinton: “I believe Capital Gains for the most part should be taxed in the same way that we tax income from hard work, sweat and toil. And, if we do these things, maybe we can be a country that can offer afford debit-free college education again.” Bill Gates similarly said, “If people want Capital Gains taxed more, like the highest rate on income, that’s a good discussion. Maybe that is the way to help close the deficit”.
The turmoil in the share market should not deter us. The leading stock exchanges of the world too plunged immediately after the Budget, just like the fall in our share market. The capital markets have their own reasons to go up and down and the same cannot be correlated with the state of the economy or because of the tax proposals. Direct taxation is a progressive tax, as per which more tax has to be paid by people who can afford it. It is desirable that we increase our income from direct taxes, as it really helps the country without being inflationary. On the contrary, indirect taxation is regressive, which levies tax equally on the rich and the poor, and it also adds to the inflation.
by S K Jha
