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Insights into Editorial: A fair tax for long-term capital gains



Insights into Editorial: A fair tax for long-term capital gains



The Economic Survey of India last year noted that India under-taxes its people, and hence under-spends, especially on social sectors like health and education. It concluded that the direct tax to GDP ratio in India is nearly at the bottom.


India’s income tax department this year released time series data for the period 2000-01 to 2014-15. Some worrying trends shown in the data are as follows:

  • There are just 18,359 individuals who have reported earnings in excess of Rs 1 crore in 2011-12 and paid tax on it.
  • Just 1% of individuals, who declared their income in assessment year 2012-13, accounted for almost 20% of the taxable income.
  • Among corporates, a little more than 5% of the companies accounted for a whopping 94% of the taxable income.
  • Direct tax collections have fallen drastically in the last five years, growing at an average annual rate of 8.5% between assessment years 2011-12 and 2015-16, compared to the 14.1% over the previous five years.
  • The drop in the growth rate of direct tax collections was accompanied by an equally dire slowdown in the growth of corporate tax. Corporate tax grew at an average annual rate of 7.1% between assessment years 2011-12 and 2015-16, down from the heady 15.6% seen in the previous five years.


With the above data, it can be concluded that Indian income-tax base is very narrow. The problem of large-scale evasion or avoidance continues.


Limitations of Indian tax structure which result in tax evasion:

  • High rate of taxation.
  • Failure to curb bribery.
  • Lack of simplified procedures.
  • Existence of large number of taxes.
  • Complex tax laws and loopholes in the existing taxation policy.
  • Lack of unorganized and systematic administrative structure.
  • Deficiencies in implementing penalty provisions.


What can be done to improve the tax base?

  • The focus has to remain on widening the income-tax base, and recent efforts to phase out exemptions must be speeded up. Meanwhile, the narrowness of the tax base should lead to some introspection on the part of the tax authorities.
  • The tax department has to work out more up-to-date methods of identifying potential taxpayers.
  • The streamlining of various data sources already accessible to the government must be carried out through cross-checking of information from various sources.
  • Using big data techniques, multiple streams of data can be mined for individuals who have consistent spending patterns in excess of their declared income. This will allow for more focused audits.
  • I-T form for those with several sources of income should be made even simpler. Online and paperless filing of returns and payment of tax should be made possible.
  • The government’s approach to tax amnesty must be re-examined in light of this data. The government needs to push through meaningful reform like taxing large farm incomes and rationalising bounties enjoyed by the well-off, to widen the base.
  • As recommended by the Economic Survey, bringing more people into the tax net through some form of direct taxation will help. In some instances, higher tax rates can also be considered by the government.


Why a tax on LTCG is a good idea in this context?

The amount of tax foregone because of tax-free LTCG can be gauged from data released by the tax authorities this year. In assessment year 2014-15, the total amount that escaped the tax net due to LTCG was Rs64,521 crore. According to another study, the loss to the exchequer due to capital gains tax exemption at Rs45,000 crore.

Therefore, the government recently hinted at increasing taxes on income from stock markets, saying the contribution of tax from those who make money on the markets has been low and they need to contribute more. This has left a large number of stock market investors worried as long-term capital gains (LTCG) on listed securities are currently exempt from tax if securities transaction tax (STT) is levied, and only short-term capital gains (STCG) are taxed.


What is capital gain?

Capital gain is the profit that one earns by selling his capital assets at a price higher than the money spent to acquire them. The difference is the capital gain (or capital loss if the selling price is lower than the purchase price).


Types of capital gains:

There are two types of capital gains: short-term capital gains (STCG) and long-term capital gains (LTCG). Each asset class has its own rules with respect to both for ascertaining income tax.  



Ever since 2004-5, long-term capital gains (LTCG) have been tax-free, and short-term capital gains (made in less than one year) are subject to a rate of 15%. The liberal treatment of LTCG was considered necessary to treat domestic stock market investors treatment on par with investors coming in from Mauritius. The tax treaty with Mauritius, signed in 1983, has cast a long shadow on India’s domestic tax agenda. As recently as this year, there were demands that the capital gains tax exemption be extended from listed stocks to unlisted stocks, and to other asset classes like real estate trusts. The treaty is also infamous for high-profile tax disputes. Therefore, the government recently amended the tax treaty. This was a relatively unsung but revolutionary tax reform. Opponents had warned that there would be hell to pay as foreign investors would flee India if deprived of the freebie Mauritius route. Nothing of that sort happened, and the amended Mauritius pact will serve as a template for other countries as well.



In this context that one must appreciate Prime Minister Modi’s recent remarks on taxing gains from securities markets. Since 1991, the economy has quadrupled in real terms, but stock market wealth as measured by the index has increased by more than 15 times. The contribution to the treasury has been less than commensurate. Correcting this would mean bringing the long-term capital gains tax at par with our peer countries.