Tax Woes Much? To Woo the Investors, Keep It Simple Mr Jaitley

Reforming the Capital Gains taxation can go a long way in attracting foreign investors, writes Sanjay Kohli.

To tax and to please, no more than to love and be wise is not given to men.

Edmund Burke

People hate paying taxes, so how can the government impose tax and also please the public. It is a sort of an oxymoron. The finance minister, however, could make some changes to how “capital gains” (profit incurred from the sale of bond, stock or real estate) are taxed in India. The idea is to simplify things for those who don’t understand tax and yet keep the system equitable and progressive.

Simple Tax Rules Bring in Better Compliance

The demand for simple tax rules in India is a uniform one, starting with the prime minister's stated objective of removing myriad rules and regulations, which strangulate the economy. Across countries, the jury is unanimous that simpler and lower taxes do result in better compliance, more tax collection and less tax litigation. Simple tax rules do not have to clash with the principle of equity and fair play. So, how can this be achieved through changes in our Income Tax Act.

Taxing Capital Gains

Traditionally, the capital gains tax is not considered a very stable one. It is marked by volatility depending upon how the markets for capital assets perform. Therefore, policy-makers prefer not to depend on Capital Gains to meet resource requirements. If we look at objectives of our capital gains tax system over the last 25 years, the laws have been written keeping the following principles in mind.

1. To encourage equity investors in listed companies – both domestic and foreign.
2. To encourage private equity investors, predominantly in technology and sunrise industries to foster innovation; existing industries like infra, real estate, construction to meet capital requirements.
3. To discourage transactions in the nature of structuring to plug loopholes for example, dividend stripping and other structured transactions to prevent big tax arbitrage.
4. To discourage investment and speculation in real estate while providing relief to the middle class owners of one house who need to sell their existing residence and buy another one.
5. To insulate the taxpayer from the effects of inflation by providing for indexation, given that our country has been plagued with periods of high inflation.
6. To include new assets like works of art, when there was a brief boom period and as the auction market continues to be stable for the masters. Also intangibles.
7. To provide the relief of lesser short-term capital gains tax as compared with the much higher corporate tax rate, on business assets, the nature of which are capital.

Working on Inherent Flaws

But, it's a new world out there:

1. Often long-term gains from the stock markets add up to a sizeable sum. A small tax on these transactions will be welcomed by most global investors.
2. The need for a stable and simple tax code, which is really quite easy for the foreigner to understand and discourages elaborate structuring as has been seen in several instances.
3. The need to encourage further, compliant behaviour with regards to capital assets like real estate, bullion, art and intellectual property, including patents, copyrights and brand values.
4. The need to extinguish earlier principles, which have become archaic. For example, the whole notion of equity transactions being treated as business income depending upon the frequency of trades needs to be done away with.

Tax Reforms

1. Reduce the list of capital assets to what is material and relevant. The concept of “block of assets” needs to be eliminated from the present tax code, as the tax differential between the short-term capital gains tax vs corporate tax rate has already been reducing and is expected to become minimal in future.

Furthermore, in comparison to the fast moving technology, as well as a certain decline in asymmetric information when it comes to land, these provisions in the Income tax Act have become archaic. Accounting profits and losses on the sale of assets, are already included in the financial statements of companies as per the accounting standards.

2. Long-term capital gains on all assets – including listed securities, mutual funds – should be at 10 percent. This includes real estate as well as non-agricultural land and agricultural land above a certain holding, apartments both residential and commercial and houses, traded shares, shares of private companies, precious metals, precious jewels, antique and modern jewellery, fixed income products, debentures and bonds from the private and public sectors including zero coupon bonds (underlying and long-term derivatives), all kinds of works of art and vintage things, valuable rights, including licences, pure brands, trademarks and patents.

3. The cut-off period to determine long-term capital assets should be an ownership of one year and while calculating the cost of acquisition where instalment payments have been made, the principle of aggregation and first-in-first-out should be taken into account. This should be followed where there is an incidence of both long-term and short-term capital gains on the same asset.

4. Short-term capital gains tax at 15 percent. Include F&O (Futures & Options) transactions. Remove completely from classifying as business profits or losses. Number of transactions should be irrelevant. No longer should any option be given to the taxpayer to treat financial securities as “stock-in-trade” for tax purposes.

Law for Capital Gains Taxes

Hence, it is proposed to have a universal long-term capital gains tax LTCG of 10 percent, based on a holding period of one year and a short-term capital gains tax STCG of 15 percent. No benefits of indexation. No carry forward of losses.

Set-offs should not be permitted between the LTCG and the STCG, but only within each category for the financial year. Doing away with the concept of “block of assets” under the head of income, “profits and gains from business or profession” and doing away with the entire Section 54 and the related calculations and exemptions while buying and selling of real estate.

Overall, these changes would be welcomed by most citizens, foreign investors and foreigners who add value and are desirous of settling in India.

(The author is a writer and an activist investor. He can be reached @sanjay_kohli. This is a personal blog and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)

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