Capital Gains Tax

Why it will not make a comeback in this budget

As the preparations ahead of the Union Budget heat up, the centre of the discussion is the highly contentious issue of tax on long term capital gains. Currently, equities held for more than 1 year are classified as long term capital gains and are entirely tax free. The argument of the government is that when interest earned by senior citizens is taxed at your peak rate why this special leeway for equities? There are 3 aspects to this argument

LTCG tax versus STT

When the securities transaction tax (STT) was introduced in 2004, the idea was to replace LTCG tax. Long term capital gains tax is hard to track since losses can be set off and losses can also be carried forward. It is therefore hard to predict how much of tax LTCG could actually generate. One of the reasons for the introduction of STT was that it was easier to administer and monitor compared to capital gains. Effectively, the STT was introduced into Indian markets as an alternative to LTCG tax. That logically means that if LTCG tax is again introduced, then it will have to be accompanied by the scrapping of the STT. That would imply a revenue loss of Rs.8500 crore annually, something the government would not be prepared for in a tight year. LTCG tax may hold a lot of promise on paper but in practice it will be much harder to monitor and administer. And the net impact may not be really better than the STT!

Nurturing the equity cult

The way the government has been cutting the rates of return on small savings, one thing is clear that the government wants to bring about a greater alignment between risk and return. To encourage retail investors into equities, the LTCG tax exemption has been a major incentive. It is very likely that if this benefit is withdrawn retail investors may find equity as an option less attractive. That is a situation that the government will want to avoid especially considering that MF inflows have been actually supporting the equity markets at a time when FPIs have been skeptical about valuations.

LTCG definition at 3 years

This is another possibility that the government is exploring. After all 1 year is not long term and 3 years is a more acceptable definition of long term. There could be two challenges here. Firstly, it could create a major confusion with respect to setting off losses and carrying forward of losses. That will be a big practical challenge for the taxman. Secondly, what happens to ELSS products? Currently, they have a lock-in of 3 years and also offer Section 80C benefits. That means; the ELSS tenure will now have to be increased to 5 years to make them at par with other equity products. That looks unlikely. The FM may finally see wisdom in just letting the LTCG exemption stay as it is! ©

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