The change needed in capital gains taxation

There’s some action afoot in capital gains rates. That much is clear from the news reports that have appeared. Beyond that, it’s all a bit murky. The government is planning some changes, but as to the details, the exact language in one news report is “… planning changes to its capital gains tax structure in the next budget, seeking to bring parity among tax rates and holding periods for investments across equity, debt and immovable property.” Another one says, “… likely to revamp the capital gains tax structure in the next budget to augment revenue collections and boost spending on welfare schemes.” That one sounds ominous— it’s hard to see how revenues can be augmented without hiking rates or broadening the tax’s applicability.

I fully believe that the Indian equity investor is a little too obsessed with capital gains tax. I’m not saying that you should not bother about it at all, or, heaven forbid, you should invest in a tax-inefficient manner or pay more tax than you need to. None of that. It’s just that whenever anyone talking to me complains too much about capital gains tax, I tend to advise them not to worry too much. After all, you are paying tax because there are gains. Think of all those investors who are not paying any tax because they don’t have any gains and count your blessings! After all, no one who has put any money in crypto is paying any capital gains tax. Aren’t those people so fortunate?

In 2018, when the long-term capital gains tax on equity investments (investing in stocks and equity mutual funds) was reimposed after a hiatus of 13 years, there was a lot of heartburn. People claimed to be re-evaluating whether they should invest in equity. Of course, it was all hyperbole. For 13 years, people had gotten used to having a channel of tax-free earnings, regardless of scale. That’s something that does not exist in any other corner of the Indian tax code.

I don’t know how many people recall that advance warning of this tax had been given by the PM himself. In December 2016, he said in a speech that, “…those who profit from financial markets must make a fair contribution to nation-building through taxes. For various reasons, the contribution of tax from those who make money on the markets has been low … to some extent, the low contribution of taxes may also be because of the structure of our tax laws. Low or zero tax rate is given to certain types of financial income. I call upon you to think about the contribution of market participants to the exchequer.” So all those who are now fantasising about a rollback to zero-tax days are very likely to be mistaken. The 10% LTCG is here to stay. The one huge and extremely unfair anomaly in this tax is that the gains cannot be indexed. It is a cornerstone of fair taxation that the government cannot ask you to pay tax on values that increase because of inflation.
On average, equity returns are rarely more than 3 to 4%above inflation. The 10% of the full returns could easily be 20 to 30% of the real, inflation-adjusted return. Therefore, this tax is likely to be 20 to 30% (sometimes more) of your returns on every transaction. In fact, I’m being quite conservative. It is entirely possible that your real, inflation-adjusted returns could be negative, and you will still have to pay this tax. As a matter of fact, when such a tax used to be there before 2005, it had an indexation facility. Now, all other long-term capital gains taxes in our country have indexation except this one. There’s no valid reason for this at all.

For those who are focused on long-term equity investing—and this is the kind of investor that India needs most of all— this is the only adjustment to the capital gains tax that is needed.

(The author is CEO, VALUE RESEARCH.)

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