The long-term capital gains tax [LTCGT] or tax on capital gains made from investment in equity shares and units of equity oriented funds [whose underlying investment is in shares] held for more than one year was withdrawn in 2004-05. This was to encourage long-term investment in equity shares and give boost to the capital market.
In budget for 2018-19, finance minister, Arun Jaitely has re-introduced LTCGT @ 10% on capital gains made in excess of Rs 100,000/- annually. However, the gains accruing from existing investment in equity shares prior to January 31, 2018 will be grandfathered. This implies that any appreciation in the value up to this date will not be considered for computing the taxable gain.
For instance, investment in a share was made on July 1, 2017 at a price say Rs 100/- and sold on July 1, 2018 at Rs 120/- resulting in a gain of Rs 20/-. Meanwhile, as on January 31, 2018, its price had increased to Rs 110/-. Then, as per the grandfathering provision, the gain of Rs 10/- made until January 31, 2018 will be excluded and the tax will be levied only on the gain made thereafter i.e. Rs 10/-.
The resurrection of this tax – after a gap of one-and-a-half decade – has caused widespread consternation in corporate circles. It has been described as a move that would hurt investor sentiment especially at a time when stock indices were moving northward propelled not just by institutional investors but also large-scale participation of retail investors. Some analysts have also attributed the carnage in stock market post-budget [market capitalization has plummeted by about 1000,000 crore] to re-introduction of this levy.
The reaction to the levy is overblown and completely out of sync with the underlying facts. A linkage is being unnecessarily established when none exists. Ever since the present government took charge in 2014, the stock market has been on ascendancy primarily due to proactive policy interventions, flurry of reforms, efficient/transparent governance and improvement in ease of doing business. During the last two years alone, the share prices have moved up by over 50%.
The rise also subsumes the effect of the ‘bull run’ in the run up to the budget which lifted the BSE-SENSEX to a new peak 36,000. The decline after budget presentation was triggered mostly by bad international news esp an indication of federal rate in USA increasing at an accelerated pace and central banks in Europe and Japan too hinting at tighter monetary policy stance. This has nothing to do with re-introduction of LTCGT, though it may have affected the sentiment in a market on correction mode.
Even so, it would be naïve to see the levy of this tax only in terms of how this will impact the equity market. The government has to take a view in the overall economic perspective. In this regard, there are two overarching considerations.
First, it needs resources to lift a vast majority of the poor out of abject poverty and invest in building infrastructure viz. roads, highways, rail, port, airport etc to lay the foundation for accelerated growth. Second, it looks for garnering resources with prime focus on those who can afford.
In the budget for 2018-19, the government has announced two highly ambitious schemes viz. (i) National Health Protection Scheme [NHPS] which seeks to provide health insurance cover of up to Rs 500,000/- to 100 million poor and vulnerable families with the benefits reaching 500 million individuals or 40% of India’s population; (ii) guaranteeing minimum support price [MSP] to farmers that is one-and-a-half times the cost of production expected to benefit 140 million farming households.
These two schemes alone would need tens of thousands crore which has to come necessarily from the budget. If, this is to be funded without causing any major slippage in fiscal deficit [that can have serious repercussion on the economy], then the government should tax the wealthy individuals. In this regard, the figures revealed by the finance minister are revealing.
During fiscal 2016-17, investors in the stock market made a whopping long-term capital gain of Rs 367,000 crore. The beneficiaries of such investment are mostly big corporate houses, foreign institutional investors, non-resident investors and high net-worth individuals. Until hitherto, these earnings were going un-taxed. The decision to tax these at a modest 10% is apt and in sync with the objective of making direct tax regime progressive.
As regards, small investors who are investing in equity or mutual fund units [with underlying investment in shares] to avail of better returns for augmenting their income, their interest has been taken care by exempting capital gains up to Rs 100,000/- per annum from levy of this tax. However, the authorities will need to take ample care to ensure that big investors do not misuse this facility by splitting their investments in to smaller lots.
While, taking a view on levy of LTCGT, any comparison of the current situation with 2004 is not valid. Then, Indian equity market was nascent and needed support. Since then, we have come a long way with stock market growing leaps and bounds. The current market capitalization at over US$ 2 trillion has reached close to our GDP of US$ 2.5 trillion. It has developed enough robustness and resilience getting increasingly aligned to the fundamentals of the companies. The market no longer needs fiscal incentives only for its sustenance and growth.
Jaitely also needs to look at an anomaly in the existing tax regime. While, capital gain on a share sold within one year of purchase [or short-term gain] is taxed @ 15%, the gain on sale after one year is treated as long-term and was hitherto attracting ‘nil’ tax. This led to unethical practices to camouflage the gain as long-term thereby completely escaping the tax. Though, long-term gain is now taxed @ 10%, the differential still remains significant at 5% prompting operators to continue with such practices.
The government should address the root cause of the problem that lies in treating holding for just over one year as long-term. There is an urgent need to increase the period of holding to at least 3 years [from existing one year] to qualify for long-term capital gain. This is particularly crucial considering that capital gain up to Rs 100,000/- per annum continues to be exempt.
To sum up, Modi – government’s decision to revive LTCGT is welcome. But, for it to have desired effect, the anomaly in regard to treatment of capital gains needs to be removed.