Budget 2020: Here’s what govt needs to do for investors in the capital market

By Sunil Gidwani and Naitik Doshi

Budget 2020-21: A lot has been written about weakening Indian economy. But interestingly capital markets seem to reflect much more positive sentiments. It’s not just the stock markets that have attracted investments despite not so positive sentiments but even private equity investment trends in 2019 also seem to suggest that uncertainties on economic and political front have not dampened the sprits of institutional investors. Yet investors in capital markets do need some improvement in tax regime. In an endeavor to retain the confidence among its investors, the government should consider the following expectations on the direct tax front.

Rollback of long-term capital gains (LTCG) tax on equity shares

Globally, most developed countries like the US, UK etc. do not have LTCG. This makes India less attractive for foreign investors (FPIs). Hence rollback of LTCG of 10% on listed equity shares is a very popular demand though the period of holding could be increased from one year to encourage longer holding.

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Abolition or deduction of securities transaction tax (STT)

STT was introduced in 2004, when the LTCG was exempt from tax. If the rollback of LTCG is not effected, then the additional tax of STT levied on every purchase and sale of security should be abolished reducing the tax burden on the investors. Separately, STT is not an allowable expense while computing capital gains. STT paid is a sunk cost to the investor while computing capital gains. Considering, STT is directly related to purchase and sale of equity shares, the same should be allowed as a deduction while computing capital gains.

Rationalizing of capital gains tax and period of holding among different securities

The tax regime for capital gains is too complex and needs simplification. Currently, there are 4 different rates of capital gains taxation i.e. 10% and 20% for LTCG and 15% and 30 % for STCG depending on the type of security held such as equity, debt, units, etc. and whether listed or not. Further, the long-term period is 1 year, 2 years or 3 years for different types of securities. It is important to harmonize the tax rates and holding period among different securities i.e. equity shares, mutual fund units and debt instruments etc. to bring consistency and ease for investors.

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Abolition of dividend distribution tax (DTT) and taxing in the hands of investors

Prior to 1997, the dividends were always taxable in the hands of the shareholders. The DTT was introduced to reduce the hardship faced in collection of tax from individual shareholders. Now with the introduction of dividend tax in the hands of shareholders earning dividend income more than 10 lakh, the tax treatment is moved back to the individual shareholders. The current mechanism leads to double taxation for large investors. To mitigate double taxation, tax on dividend income should be at the shareholder level alone.

Accord pass through status to Category III AIFs

Currently, category I and category II AIFs are granted pass through status and taxable in the hands of the investors. With increase in surcharge rates for high net worth individuals by the Finance Act, 2019, taxation at the fund level for category III AIFs would lead to disparity of net tax rates. At the Fund level, surcharge at highest rate would be applicable which would adversely impact the investors falling in the lower tax bracket but still be subject to surcharge of 37%. A ‘pass-through’ status will ensure fairness in the tax treatment for all investors.

Uniformity of tax treatment for investment in mutual fund units and unit linked investment plans (ULIP) of life insurance companies

The tax treatment in respect of investments in mutual funds units is adverse as compared to ULIPs of life insurance companies. Switching of units within the same scheme of a mutual fund is subject to capital gains tax viz switches to various investment plans of the same ULIP is not, capital gains on proceeds received from ULIP continue to remain exempt in comparison to capital gains on mutual fund units which is subject to LTCG/STCG. It is important to rationalize the same and grant capital gains exemption on mutual fund units, to ensure a level playing field among similar investments.

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Sunset clause for lower tax rate of 5% with respect to interest income earned on bonds and Government securities to be extended

To promote investments by foreign investors in debt, the lower of withholding rate of 5% is available on interest income earned by foreign investors on certain bonds (in INR and foreign currency) and government securities. The benefit should be further extended for 3 years to boast the debt markets.

Alignment of income-tax provisions with the amended FPI Regulations 2019

SEBI FPI Regulations, 2019, have been revamped recently reducing the erstwhile 3 FPI categories to 2. The Income-tax laws need to be aligned with the changes, specifically related to offshore transfer provisions where currently category I & category II FPIs are exempt. Ideally in line with earlier demand, the exemption for all categories should be granted in view of complications to comply with the said Provisions.

Sunil Gidwani is Partner and Naitik Doshi is Manager, Nangia Andersen LLP. Views are the authors’ own.