OECD for long-term capital gains tax

Written by Sharad Raghavan | New Delhi | Updated: Jun 16 2011, 02:15am hrs
The Organisation for Economic Cooperation and Development (OECD) has said India's decision not to impose a tax on long-term capital gains is a step backwards and will perpetuate tax avoidance. In 2009, the government decided to do away with the long-term capital gains tax in a bid to reduce the tax advantage enjoyed by those who used the Mauritius route to invest in the Indian stock markets.

The report 'OECD Survey of India' said the Indian government's unwillingness to lower the tax on short-term capital gains proved to be counter-productive.

While India is not an OECD member, the organisation that brings together 34 developed countries considers New Delhi as an engagement partner. China and Brazil also fall in this bracket.

The OECD comments are significant as its tax theories are the model successive Indian governments have used to develop the country's revenue raising capacities. This includes transfer pricing as well as anti-evasion tax policies.

As part of India's Double Taxation Avoidance Agreement (DTAA) with Mauritius, international investors with base in the island enjoy a tax exempt status compared to their Indian counterparts. To level the playing field, the Indian government defined short-term as amounting to one year, for which the tax on capital gains would be 10%. More than a year constitutes long-term, for which there was no tax.

The report also has comments on the new Direct Tax Code, which will come into force in 2012. The Code will reduce the corporate tax to 30% in 2012 from almost 34% in 2009, and do away with all area-based tax allowances and holidays, including those for SEZs approved after 2014. The allowances will be replaced by a 100% depreciation rate in the year the investment is made in certain sectors of the economy. This, the report says, tends to favour capital-intensive operations, reinforcing the bias against labour-intensive projects. Along with this, the Code increases the minimum effective corporate tax rate payable in a given year to act as a check on very large investments in relation to current profits.

The report goes on to say that this measure biases the tax system towards large companies with an established profit base over start-ups with no existing profits.

Apart from the Direct Tax Code, the report analysed India's economy as a whole, with a focus on education. In India's bid to sustain high rates of growth, the report emphasises the need for greater transparency and accountability in public governance. The report also says that while growth in India has been rapid, poverty remains high. Towards this, it says that the government must strive to make India's growth story more inclusive.

In the banking sector, the report says the entry of new private players has heightened competition and has increased efficiencies. It recommends granting of more banking licences to aid this process.