MUMBAI: The argument is that income that an asset generates should be booked to tax, irrespective of whether it is a human asset or a capital asset. Subjecting individual incomes to tax, and exempting capital assets from tax, creates incentives to engage in acquisition of capital assets, without deploying such resources in income generating activity. The implementation, however, betrays this intent.
Should there be disincentives to acquiring capital assets? There are two arguments here. The first is that exempting capital gains from tax favours the wealthy. The second is that appreciation in capital assets is the primary source of bequests, and in regimes like India where estate duties are not levied, exempting capital gains from tax means wealth accumulation is perpetuated and transferred to heirs, without any benefits to the government or society.
But capital gains are the primary incentives to entrepreneurship. Investors in equity take on the risk of the business in return for potential appreciation in the value of their investments. Such incentives would diminish if capital gains, especially long term capital gains, are taxed. The low or nil rates of taxes on LTCG enables risky entrepreneurship and extensive participation in equity of emerging businesses by public investors. Given the substantial nature of capital gains, most regimes tax them anyway. As the FM mentioned, the returns are large enough post-tax too.
A case can thus be made to tax capital gains, in normal course. As if they were a source of income and by inclusion in accounts and returns. The Indian story is somewhat different. Capital gains are not taxed at source. By their very nature, they have to be accounted for while preparing the income tax returns, transaction by transaction. The onus of paying taxes on capital gains is on the taxpayer.The intent of the tax is thus a direct disincentive, which is why the market has reacted negatively. The effect of the tax is to reduce the post-tax return to the investor by imposing a flat levy. However, leaving that levy to the compliance conscientiousness of the taxpayer is inefficient. A tiny uptick in STT would have garnered more resources with better efficiency, if revenue mobilisation was the requirement. That does not seem to be the case. The wording in the speech and intent in the Finance Bill seem to simply levy a tax on something that seems large, substantial, and accruing to a large number of participants.
