As the final countdown for the Budget begins, all attention is towards what measures the Finance Minister introduces in terms of tax relief. Even across the equity markets, investors are awaiting with bated breath for a possible tweak on capital gains tax.
In a recent post on the social platform X (Twitter), Helios Capital founder Samir Arora highlighted how different forms of investment income are taxed. He said that comparisons between capital gains tax on equities and tax on interest income often miss a crucial point. The government’s net tax collection depends on whether there is a matching tax loss on the other side of the transaction.
“Simply because when you buy debt/FD and report an interest income (and therefore pay tax on it), another party reports the same amount as interest cost (and therefore saves tax). So, the government does not benefit much in aggregate from tax collection,” he said.
The derivatives ‘zero-sum’ game
Drawing a parallel with futures and derivatives trading, Arora said that for every trader who makes a profit, there is another participant who incurs an equivalent loss. While the profitable trader pays tax on gains, the losing trader can claim a tax deduction for the loss.
He explained that, as profits and losses vaguely cancel each other out, governments can impose relatively higher tax rates on derivatives profits without significantly increasing the overall tax burden on the system.
Separation of long-term equity tax from capital gains tax
Further, Arora pointed out that in the case of long-term equity, what investors exchange is post tax income of the company or the dividend stream, which is anyway taxed separately. “One investor making big capital gains is not normally accompanied by another fellow claiming an equal loss.” This means that the sellers might have had an opportunity loss but not a claimable tax loss.
To summarise, he said governments worldwide collect a lot more on cash equity gains than what is seen at first glance, as there is no other side claiming a loss to counter profit. Therefore, a tax offset. Also, capital gains tax cannot be compared with tax on interest income by conveniently leaving out STT.