All through the morning we have been talking about the modus operandi used by the finance minister as well wherein the ministry called up every known machinery in the media and otherwise and told them to make sure that the message that the FM gives out on Sunday evening is carried out loud and far seems to suggest that there is no long-term capital gains tax in the offing at least in the current budget. How are you reading what happened between Saturday and yesterday?
I think it is very reassuring and proactive on the part of finance minister to assuage feeling of investors. There cannot be any debate that there should be fair and equitable burden distribution of taxation and in a country where the tax to GDP ratio is so low, prime minister is absolutely right in saying that people should contribute to taxation system. The FM has also been proactively assuring equity investors that there would not be any change in long-term capital gains. So in a way both of them are right and it is fantastic to hear from finance minister assurance to the capital market investors on capital gains
While the finance minister has categorically and vehemently denied the long term capital gains tax, what could actually come about because the prime minister has talked about measures of taxing people who are right now making tax-free money from stock markets? What are the other measures that perhaps could come if not long term capital gains tax?
They should try to plug the loopholes which exist in today’s taxation system which allows people to earn income but not to pay tax. One of them is commonly known as bonus stripping. By some quark of rule, we make acquisition cost of bonus share zero rather than prorate dividing the original holding cost. This creates a cottage industry of people claiming short-term capital loss on bonus shares as and when they are declared. This provides a legal way of avoiding tax.
This loopholes can be plugged and there is probably Rs 10,000 crore plus kind of tax collection if we can plug this loophole. The second thing is related to exemption given to listed promoters vis-à-vis unlisted promoters. A small entrepreneur, whether he is running a proprietary firm or a partnership firm or unlisted company, whenever he sells his business, he pays full tax. But when a listed entrepreneur sells the business, he does not pay any tax because he claims exemption under capital gains on listed equity.
I think the objective of capital gain should be for retail investors rather than promoters. There is today disparity between promoter selling their business in listed companies vis-à-vis unlisted enterprises that disparity must be stopped and promoter selling their companies whether it is listed or unlisted should be taxed.
The third thing where SEBI has done a commendable work is related to long term capital gains in illiquid scripts. We see occasionally illiquid scripts rising multiple times. Clearly there is a cottage industry going on whereby people buy illiquid scripts at very low price and after holding at a high price, they sell it and book a lot of capital gains. That cottage industry needs to be stopped.
Number four, people have started finding loopholes in conversion of interest income into capital gains. They buy zero coupon listed debentures and after 12 months when the debentures are sold, they are being countered as long term capital gains and hence no income tax is paid on net. Now interest is interest. They cannot be converted into capital gains through this kind of loopholes. So instead of raising taxes by taxing long term capital gains on equities, I think if we plug all these loopholes of bonus stripping, dividends stripping, listed entrepreneur versus unlisted entrepreneur disparity, long-term capital gain on illiquid scripts and such kind of conversion of interest income into capital gain, if we plug all these loopholes, I think government will collect more than what they are expecting today by altering taxation system.
You have been speaking about the taxation on FIIs. Now remember the last two days ever since this has happened, one thought process has also been that there could be some taxation changes in tax meted out to FIIs, P-notes so on and so forth. Do you think anything like that could come about in the budget?
We have reassured FIIs time and again that we will not change the past structure or past double taxation treaty and whatever changes we want to do should be with perspective effect and not with retrospective effect. I think every time we have tried to go retrospectively into FII taxation, markets have corrected and then due to the correction pressure or otherwise we have to go out to reassure them. This happened in 2015, so we must learn from our past experience and not do anything retrospectively, do everything prospectively.
Second important point is to keep parity between domestic capital and foreign capital. Colour of the money is same. We should not go back to the earlier system that domestic investors were taxed at higher rate and foreign investors were taxed at a lower rate. It unnecessarily encourages P-note business. We should give parity between domestic capital and foreign capital and we should do everything to prospectively rather than retrospectively. It is government’s choice, it is government’s imperative to decide how to tax but if we plug the loopholes, my guess is that we would not have to make any changes in existing system of taxation.