TAX NEWS - June 2010
Taxing capital gains fully a bad move
In an interview to CNBC-TV18, Ashvin Parekh, Partner and Global Leader, Financial Services, Ernst and Young and Nishith Desai, Founder, Nishith Desai Associates have shared their views on the significant changes.
According to Parekh, taxing capital gains as business income is a bad move. He added that indexation may take away a part of the blow, as it is likely to be a combination of inflation and investment incentive.
On an optimistic note, Desai said that FIIs would see a high capital inflow as they will gain tax as added cost. He added that Securities Transaction Tax (STT), a tax being levied on all transactions done on the stock exchanges has been successful.
Below is the verbatim transcript of their comments on CNBC-TV18. Also watch the accompanying video.
Q: The one which is causing some consternation for the market is capital gains suggestions that short-term and long-term become one and they now get taxed as income from ordinary sources. The fear is that we are getting back to full taxation on equity market profits as well? What did you read into the proposals yesterday?
Parekh: I thought for a certain period we had a clear distinction on capital gains, perhaps the term as you called it long-term and short-term could have been reexamined but the idea of dropping that altogether and then making it a part of the regular income and taxing it at the regular rates isn't a progressive move particularly for the markets. So the investors are going to look at it and more closely examine it, it is not a very welcome move.
Q: What implication does it have on FIIs because their income now will also be subject to capital gains and not be treated as business income – could that be potentially negative, could that imply a higher rate of taxation even for them?
Desai: Absolutely because conceptually FIIs consider foreign tax as a cost and domestic tax often as an obligation just as a concept. Therefore every additional burden you put on the FII, they would always look at what is going to be the net of tax returns to their investors overseas and the regime which was getting nearly settled. I think we are unsettling the whole regime and that doesn't seem to auger well for the foreign institutional investors and much depends on what kind of tax rates we come up.
Some of the schematics are there in terms of special deduction provided etc. The worse is that you are trying to twice tax the same income; one is form of capital gains and second in form of STT. In fact that is the basic tenet of the tax regime that you cannot tax the same income twice.
So in the garb of STT which is more like a sales tax incorporated within an income tax, I personally feel that is not fair. I think there cannot be double taxation of the same income even on a presumed basis that is what is incorporated in STT.
We had very good regime going on STT, it is very simply. Good revenue collection, even if you don't have capital gains tax, STT can do a lot good to the economy, less bureaucratic. This does not seem to be going very well unless the market performs exceedingly well all the time then people will look at it that this tax can be absorbed, that would be my reaction to the FIIs. Other important thing is tax credit is a problem in the foreign category.
Q: The caveat to this is that for holdings of more than one year profits can be reduced by a specific rate- do you have any clarify on what this specific rate could be because on that might hinge the kind of confessional long-term capital gains tax might have as it does today?
Parekh: There is no clarity yet, we will have look at the fine print, and look at the final code that comes out- what has been issued is 35 pages of just the 11 changes which are being suggested in the revised discussion document.
However I must admit that if the concept of indexation is introduced for the purpose of the gains in this segment then it may take away a certain amount of the blow in which case like what is that Indexation, how is that worked out and does it really go with the period over which the investment is held is something that will have to be examined.
Q: Indexation on the basis of what because if it is inflation it will hardly take away a small part of the pain- can you think of what could possibly be that indexation bench mark be?
Parekh: Either it could be linked to some inflation plus, some kind of an incentive for the investors to hold the investments. And I am encouraged to say this because in some of these investments particularly those five investments meant for individuals in the government provident fund, in the public provident fund and the other three categories there is a direction to encourage long maturity savings or long maturity investments.
So if I have to really borrow the concept from there, then I would assume the Indexation would certainly be inflation plus kind of an indexation, just to encourage long maturity or for people to hold on to their investments perhaps.
Q: Have you clearly understood the new dispensation on STT would be because it seems to be now coming back although in a calibrated manner along with capital gains moving to maybe business income, what is it implying?
Parekh: If you look at the discussion paper, there is only one paragraph on this and there is the aspect of liberated structure and one will have to look at the code document and see the revised document and see what exactly is meant by this calibrated approach for the STT. In the absence of that there is not clarity yet in the description that has been rendered so far, in the paper that came out yesterday.
Q: Whatever the long-term capital gains tax eventually turns out to be because of the specific rate and the Indexation that you speak about - short-term capital gains tax does it straight away go to the highest payable tax rate now?
Parekh: There are two concerns in that particular case as I see it; one is that it goes at the highest rate to begin with and the second is the clarification that was rendered yesterday at the press conference saying that the rates which have been indicated in the original tax code are illustrative and the parliament will determine the rates on an annual basis.
So we are going back to a point where the short-term capital gains will be taxed in the normal income rates or the tax rates but the rate themselves will be determined by the parliament on an annual basis, so that takes away any long-term planning aspect out of the rate structure that was originally conceived or it was originally talked about in the DTC. The principle was that there was a long-term approach to the rate structure that is been withdrawn I suppose.
Q: Do you have any clarity on what this means for taxation on equity mutual funds versus ULIPs because there was some observation that whatever was suggested yesterday actually favours equity mutual funds over ULIPs?
Desai: I don't have a great deal of clarity at this point in time everything is evolving and on one hand I personally think that on the whole, it is a very good exercise and I am happy because what we saw was a completely distorted version earlier of the tax code and there is significant improvement in this particular discussion paper. Actually we need to establish a Law Commission to redo the whole act; I think this is a very piecemeal approach.
But constructively speaking and positively looking at it this is a significant development lot of things are coming up, and there is a lot more clarity that will be required and other small thing I mentioned at this point that there are so many provision at the macro level which are not addressed in this but I hope they will be addressed as you go along.
For example I am very keen to see reincorporate tax payers rights within any legislation you bring about because that will be the best way to develop co-operation between the government or the tax department and the tax payer, so both know their own limits and within what framework to work for.
Q: Do you have any clarity on taxation on equity mutual fund profits versus ULIPs?
A: Basically ULIPs from taxation point of view never did enjoy any significant tax benefits, they were more or less at par with the normal equity or debt taxation that was prevaling before the code was introduced except that the payment made to Ulips for example came from out of the overall 11-12 different investments which were permissible, so there was absolute nothing significantly different in that regard. Now also since there is no mention of ULIP either in the EE category nor is there any special move to tax ULIPs any differently form the Equity mutual fund products. I assume that there is absolutely no change in the revised discussion paper that has really come out yesterday.
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