Thanks to prime minister Narendra Modi’s statement that the rich didn’t pay taxes on either their dividend income or on capital gains on shares—at the Airtel-Economic-Times Business Summit at the beginning of the month—rumours are rife that, come February 29, finance minister Arun Jaitley will change this. One option being talked of is that no tax exemption will be given for capital gains made on investments held for less than three years, as opposed to the current one year—this is the tax treatment for unlisted securities even today as well as that for debt. Apart from the fact that it is simply not true that no capital gains taxes are paid or that dividend income is not taxed, this would be a very bad idea. Certainly, a level playing field is required—the government has, in any case, promised investors in start-ups that they would not be paying capital gains taxes on their profits. But increasing the lock-in period for listed securities to three years will be seen as a big negative for investors, particularly those from overseas—in any case, with the Sensex losing 19% since the time the last budget was presented, and the rupee another 9%, it’s been a double whammy for foreign investors. Ideally, all that needs to be done is to lower the lock-in period for unlisted securities to one year as well. As for the prime minister’s statement, till 2004, India charged a capital gains tax on shares, but collecting it wasn’t easy. As former finance minister P Chidambaram, who abolished the tax in 2004, said, “capital gains tax is another vexed issue … questions have been raised about the definitions of long-term and short-term, and the differential tax treatment meted to the two kinds of gains”. Which is why, a securities transaction tax (STT) was introduced on all stock market transactions—the Rs 5,992 crore it fetched in FY15 is nothing but a tax in lieu of capital gains tax and it is the rich who are paying this. The finance minister is welcome to go back to the old capital gains tax structure, but collecting it through an STT is far easier.
The situation isn’t too different in the case of taxes on dividend since, in FY14, companies paid Rs 25,086 crore as dividend distribution tax (DDT) on behalf of investors who owned shares—this is, in addition to the 34% rate paid on their profits. It is true that the DDT of 20% is a source of inequity in the sense that a pensioner with shares is charged the same rate as a Mukesh Ambani—this, of course, is the genesis of the famous Warren Buffett statement that he paid a lower tax rate than his secretary did. Scrapping the DDT and taxing dividends in the hands of shareholders is an option—the pensioner will then probably pay no tax while Ambani will pay the top rate of 34.6%—but it is not clear if it worthwhile to shift from a sure-shot method to one where collections may not be that easy; taxpayers could, for instance, choose to hold securities in tax havens. Moving to this system, though, will be welcome by foreign corporations since, right now, they don’t get a tax credit in their countries for DDT; on balance, it would appear the finance minister would do well to let the status quo remain.