Not investor friendly


The NDA-government’s decision to re-impose the long-term capital gains tax (LTCG) on equities, which was scrapped in 2004-05, seems to be a hasty move to plug the widening fiscal deficit ahead of an election year. With investors in equities enjoying terrific returns over the last few years, it is not a surprise that they have become targets for the central government to secure additional revenue. The decision to announce the imposition of 10 percent tax on gains of over Rs 1 lakh made on any form of investment in listed equities and mutual funds with a holding period of over one year will hit the average middle class investor. The number of such investors is not very high but they are the people who have been looking at gains close to their retired life after active service. This also forms a major source of savings, which are usually done by service sector people for the rainy days when their incomes are not considered enough to meet their daily life needs. Moreover, such savings are very small part of their earnings which go into long term investments for the gains to be enjoyed when their income goes down by half in the retirement period. Not surprisingly, the sharp fall in both the Nifty and the Sensex after the Budget Day has been linked to the new tax, along with the central government’s abandonment of fiscal goals. But given that the sell-off was part of a wider correction in global stock indices, it may be hard to draw a definite conclusion on the exact impact of the LTCG. As such, the central government has not been in a position to give out the figures that would go in its kitty for increasing the tax collection. Previously, such investments of the middle class have been free from taxation because some of the equities might be held by the investors over a period of one or two decades. Some of them also include the investments made through postal bonds or other investment bonds and later converted into equity by the companies with assured returns. The security offered by the companies in the form of mutual funds to the investors with gains after conversion to equity will also be hit by revival of such a tax regime. The centre has justified the new tax arguing that it helps avoid the erosion of its tax base and levels the playing field between financial assets and investment in manufacturing. One legitimate concern is whether raising the tax burden on equities, rather than lowering the tax and other barriers to investing in alternative assets, is the right way to address the distortions in tax collection and re-imposition. Moreover, the smaller differential between short and long-term capital gains tax itself will discourage the long-term holding of stocks in favour of short-term trading activity. While this might serve to improve liquidity in Indian markets and add to the central government’s revenue, it is also likely to discourage to some extent the growing culture of investing in equities for the long run. Besides, the Securities Transaction Tax (STT), which was introduced in lieu of the LTCG in 2004 and penalises the buying of stocks for purposes other than just intra-day trading, has been left untouched by the NDA-government. The double whammy of the STT and LTCG will further privilege short-term trading in stocks over long-term investment. Being the only country in the world to impose both STT and LTCG, India is also likely to become a little less attractive to foreign investors when compared to its peers and the developed countries. A complete rollback of the new tax is too much to expect – Finance Secretary Hasmukh Adhia has justified the higher tax levy saying that the capital gains accrue from zero effort. Despite the constraints, the central government would do well to at least soften the negative impact of the revived tax by allowing indexation – allowing a set-off based on inflation rate – of capital gains and removing the STT on equity investments. This is the norm that rules these taxes in the developed countries. Tough love for the well-off is not a bad strategy for a pre-election Budget, but it is important to be careful about maintaining India’s credibility in the global money markets in the process.