Capital gains

Simplifying taxes will improve collection

One of the welcome highlights of the Union Budget on Tuesday was simplifying the structure of capital gains tax. Union Finance Minister Nirmala Sitharaman announced short-term capital gains on certain financial assets would be taxed at 20 per cent as against 15 per cent earlier. All other financial and non-financial assets would continue to attract the applicable rate. This meant short-term gains in the stock market would now attract a tax liability of 20 per cent. Further, long-term gains from all financial and non-financial assets would now attract 12.5 per cent tax. Long-term capital gains tax on listed equity was 10 per cent. One of the driving factors for increasing the difference between long-term and short-term capital gains tax could be to encourage long-term investment in capital markets, particularly by households.

For the benefit of the lower-income class of investors, the minister increased the limit of exemption from Rs 1 lakh to Rs 1.25 lakh. Listed financial assets held for over a year will be treated as long-term. In the case of unlisted financial and non-financial assets, the minimum holding period to be classified as long-term will be two years. Unlisted bonds and debentures, and debt mutual funds, will attract capital gains tax at the applicable rate. The announcement of increasing capital gains tax on listed shares unnerved the stock market on the Budget day, resulting in significant volatility, though the benchmark indices recouped most of the losses by the end of the day’s trade. There was concern also in real estate because capital gains will now be taxed at 12.5 per cent without the indexation benefit. It was earlier taxed at 20 per cent with the benefit of indexation. However, as the government has explained, it would benefit most real estate investors. Further, the tax will be exempt in case the gains are used to buy or construct a house worth up to Rs 10 crore. It would also be exempt in the case of investing in specified bonds up to Rs 50 lakh.

The proposed changes clearly have two interdependent objectives. The idea, as the minister noted, is to simplify the tax structure. It is further hoped that a simplified tax structure will help improve tax collection. The market should be able to adjust to a higher tax rate without much difficulty. At a broader level, if the economy continues to do well, which is reflected in earnings and stock price appreciation, the market should not have a problem. Some of the advanced countries have a much higher tax on capital gains. Higher taxes on earnings from financial markets are also progressive. It is the well-off sections of society that invest and gain from capital markets. Nonetheless, what may worry investors is the uncertainty on the tax front. The FM in her Budget speech announced the government would be reviewing the Income-Tax Act, 1961, over the next six months. The review may further lead to changes in the capital gains tax structure. Therefore, it would be advisable to revisit the idea of bringing a direct tax code with the aim of providing stability and certainty to the direct tax structure.