Taxation of capital gains has been a bone of contention among tax experts, legislators, officials, economists and investors in the last few years. The Income Tax Act divides the capital gains on the sale of a capital asset into short-term and long-term. Capital assets are shares, bonds, units of UTI, mutual funds, fixed return instruments, gold and real estate (non-agricultural land, flats, buildings, shops, offices). While the holding period for long-term capital gains for shares and equity mutual funds is 12 months, for all other assets it is 36 months. In the last Budget, Finance Minister Arun Jaitley reduced the holding period for land, building and house property from 36 months to 24 months. This offered greater liquidity to land and real estate investments and increased their supply for sale.
The logic for distinction between short-term and long-term capital gain world over is the goal of fiscal and taxation policy to promote capital formation or building of capital assets in the economy that generate economic growth. If the economy has to grow at a higher rate, it must have higher asset formation that builds productive assets. Hence, to encourage investment and holding of long-term capital assets, gains on their sale is taxed at a lower rate than the short-term assets.
So far, as the tax rates are concerned, equity shares and equity mutual funds are given preferential treatment by making them free of tax on long-term gains. Short-term gains are taxed at 15 per cent. All other short-term gains are taxed as per the tax bracket of the assessee. For all assets other than shares and equity mutual funds, the tax rate is 10 per cent without indexation or 20 per cent with indexation. In order to extend some relief to tax payers for price inflation, the ministry gives the Cost Inflation Index (CII) that can be used for calculation of capital gains after indexation of the acquisition cost. Last year, the ministry gave a new index with 1981-82 as the base of 100 and having the value of 272 for the year 2017-18.
What are the issues discussed on the possible changes in this area of taxation? The most contested topic is the zero tax on long-term gains on shares and mutual funds. During Prime Minister Narendra Modi's recent meeting with prominent economists, there was a unanimous suggestion to tax these gains that provide a discriminatory and favorable treatment to equity investment against debt and other capital assets.
The argument for zero tax on capital gains on equities is that it aims to drive the equity culture in the economy and getting larger population in this asset class and risk capital which is crucial for growth of the economy. Further, equity investment is already taxed with 20 per cent dividend tax. Why tax risk capital again?
Several changes are possible. The holding period of 12 months for equity and equity mutual funds could be raised to 24 or 36 months. From zero tax, the gains could be taxed at 10 per cent without indexation and 20 per cent with indexation on par with other assets. Or alternatively, the finance minister may maintain status quo on the issue.
Disclaimer: The views expressed in this article are solely those of the author and do not necessarily represent the views of the publication.
