The capital gains tax regime was proposed to undergo a complete revamp under the Direct Taxes Code (DTC) provisions. The DTC proposed to remove the distinction between long-term and short-term capital gains. Any gains arising from the sale of investment assets were liable to tax as capital gains at 30 per cent in case of non-residents and the applicable marginal rates in case of residents.
The revised discussion paper provides that income from capital gains will be treated as ordinary income and taxed at rates applicable to respective taxpayers. This could be beneficial to individual taxpayers in the lower slab. Also, the revised discussion paper reinstated the existing system of long-term and short-term capital gains, depending on the holding period. The period of holding to classify a long-term asset is now considered one year for all these, as compared to the existing tax system of one year for shares and three years for other assets.
One of the major concerns in the DTC provision was removal of the STT regime and, therefore, transfer of listed equity shares or units of equity-oriented funds was considered taxable at 30 per cent in case of non-residents and at applicable rates in case of residents. The government has noted in the discussion paper that the rate of 30 per cent for taxation of capital gains in the hands of non-residents is very high in case of listed equity shares, since currently they are being taxed at a nil rate, if held for more than one year. The revised discussion paper tried to mitigate the hardship of the new provision but not done it completely. The paper provides that capital gains on transfer of listed equity shares held for more than a year would be taxed after allowing a certain prescribed percentage of capital gains as notional deduction. The specified rate of deduction has not been notified but a rate of 50-70 per cent of capital gains has been indicated. The effective rate for a taxpayer whose applicable marginal tax rate is 30 per cent could be between 9 and 15 per cent, very high in comparison to the nil income-tax currently applicable. It is to be noted that the Kelkar Committee report on direct taxes in 2002 had indicated that tax on long-term capital gains effectively leads to double taxation and, therefore, should be exempt from tax.
The discussion paper also seals the controversy surrounding the characterisation of income earned by foreign institutional investors (FIIs), by specifying that it will be deemed as capital gains and not business income. This would mean reliance on the capital gains treaty exemption clause by the FIIs much more than before. Separately, the discussion paper provided that income of FIIs shall not be subject to tax withholding and they will continue to pay advance tax in the normal course.
While the revised discussion paper has addressed some broad issues, which attracted sharp criticism from several quarters, the government is still to provide clarity on issues relating to business reorganisation, indirect transfer of assets, etc. Further, the tax cost on sale of listed shares could still become a damper to FIIs in the Indian stock market and the government should consider further relaxation, either in the rates of notional deduction or the tax rates itself.
Shyamal Mukherjee Executive Director & Joint Leader of Tax Practice, PricewaterhouseCoopers