Commerce for IAS – Taxing Stock Market Gains

In a recent speech, Prime Minister in context of taxing equity gains, asked market participants to make a ‘fair contribution to nation-building’. Though, Finance Minister was quick in dousing the situation, the remarks made need greater deliberation.

Present Taxation Scenario:

For equity and equity mutual funds, long-term capital gains are entirely free of tax. There’s a concessional 15 per cent tax on short term capital gains and dividends are subject to a distribution tax of 15 per cent.

The UPA government, in 2004, decided to slash capital gains tax on equity to replace it with STT. STT, collected by the exchanges, was seen to deliver more revenues to the exchequer than capital gains tax.

But in practise, the tax hasn’t really lived up to this promise. STT has collected just ₹6,500 crore to ₹7,500 crore in recent years, chipping in with just 2 per cent of personal income tax collections.

FIIs – the most active market players — have traditionally gotten get away with nil capital gains tax, by routing their exposure through low-tax regimes and taking shelter under Double Taxation Avoidance Agreements (DTAAs).

Domestic institutions such as mutual funds enjoy pass-through status on taxes. Many retail investors avoid declaring equity capital gains, as compilation is cumbersome.

Case Against Taxing Equity Gains:

One line of reasoning is that these tax incentives are needed to encourage financial savings.

Stock market players argue that because Indian households are generally risk averse, they need special allurements to invest in equity.

To induce first-time investors into financial savings.

Case for Taxing Equity Gains:

In recent years most financial instruments have been brought under the taxman’s net including interest received on bank and corporate deposits, Returns on post office schemes (save two) and gains on bonds and debt mutual funds. Hence, similar treatment needs to be meted out to equity.

It can be argued that, secondary market transactions in stocks do not really help the economy as they don’t create new assets.

Way Forward:

The time appears right for policymakers to overhaul the tax regime for equities. Doing away with STT and extending the holding period for equity investors to claim the ‘long term’ capital gains benefit to 36 months, can be good first steps.

Moving from STT to a capital gains tax regime may be not be all that bad for the equity investor either. Today, you shell out STT on all your share trades irrespective of whether they finally earn you a profit or a loss.

Further, once its own tax revenues are linked to market fortunes, the Centre would have a vested interest in ensuring that equity investors do pocket some capital gains. This may also prompt the Government to weigh the stock market reaction before unleashing any policy bombshells.

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