Level the playing field

Long-term capital gains tax benefits for equities should go

The Bombay Stock Exchange’s (BSE) suggestion that benefits related to the long-term capital gains (LTCG) tax on equity investments should be removed to curb market manipulation via the exchange platform deserves serious thought. Though this demand has emerged from several quarters in the run-up to some earlier Budgets as well, the government has been ignoring it on the grounds that a differential tax treatment is required in order to encourage long-term investments instead of short-term trading in the capital market. India used to tax capital gains on equity till 2003-04, when the then finance minister, Jaswant Singh, proposed to abolish it for securities held for more than a year. This was to be reviewed in a year, but the next Budget in 2004-05, presented by P Chidambaram, carried forward the idea and imposed a securities transaction tax to make up for the tax loss.

According to the current tax norms, an individual is not required to pay any tax on gains from equities if the shares are held for a period of more than a year. But the need to review this has gained urgency after the Securities and Exchange Board of India (Sebi) recently barred 240 entities and individuals for making illicit gains through LTCG tax benefits. According to Sebi, the modus operandi used by companies is to make preferential allotments to known entities. These shares are locked in for a year if allotted to promoters and for three years if allotted to non-promoters, and often allotments are made to ‘benami’ entities that are closely linked to promoters but are not classified as such. These entities act in concert and use the stock exchange to artificially increase the volume and price of the scrip. The BSE’s suggestion that the differential tax treatment for listed and unlisted shares be done away with is also a sensible one as that is the only reliable way of curbing tax arbitrage between the two categories of securities. The LTCG tax on stock investments in unlisted companies is 20 per cent if the investment in such companies is sold before three years.

Then there is the question of a level-playing field. There is no reason why equity investments alone should continue to enjoy star billing among investments in bonds, real estate and gold, where the asset is considered held for the long term only if not sold for three years. The tax rates, too, favour equity, with zero taxes to be paid on profits if a stock is held for more than a year. In lieu of these tax breaks, equity investors are required to pay a securities transaction tax of just 0.10 per cent of the trade value. The argument that Indian households are generally risk averse and need special allurements to invest in equity is a fallacious one. Even the logic that it was necessary to treat domestic stock market investors on a par with those in Mauritius is no longer relevant as the tax treaty with that country was amended this year. In a speech a few days before last year’s Budget, Prime Minister Narendra Modi had said the low contribution of taxes might also be because of the structure of the tax laws — low or zero tax rates on certain types of financial income. Though last year’s Budget did not take any steps, it is clear the zero-tax status for LTCG in equity investments has been living on borrowed time for a while now. The next Budget provides a good opportunity to walk the prime minister’s talk.