With Union Budget 2023 round the corner, finance minister Nirmala Sitharaman is once again inundated with many a wish lists. One area that finds a mention every year in the run up to the Budget is the capital gains tax (CGT) regime . Given the many disparities in the extant regime, there is a need to simplify it. In this column, we will highlight some of these disparities. It looks likely that the finance minister may pay special attention to it this year, given the comments made by the Central Board of Direct Taxes chairman and others hinting at structural changes in the manner in which capital gains are taxed. However, the tax authorities have been reticent about the specifics of these changes. Nevertheless, we expect certain structural changes focussing on rationalizing the CGT structure by bringing in more parity, simplifying categorization, etc.
Currently, different asset classes have different holding periods, which determine their classification as long-term capital asset or short-term capital asset. This categorization, in turn, has a bearing on the computation of capital gains, including the applicable tax rates (including surcharge) and availability/ non-availability of indexation benefits.
The devil is in the details
Currently, when a non-resident sells or transfers listed or unlisted securities, he/ she is subject to 10% long-term capital gains (LTCG) tax. However, resident investors can only avail of the beneficial CGT rate in case of LTCG arising from the disposal of listed securities, while being subject to a 20% tax rate in case of sale of unlisted securities, i.e., double the rate applicable to non-resident taxpayers. This disparity results in domestic investments gravitating towards public equity markets, which is seen as being more liquid and providing greater tax benefits. Such differential taxation system ought to be harmonized to provide impetus to domestic investments in private companies. Parity in treatment shall also usher in stability in inflow of funds, innovation, and economic growth. The Indian government can also take a cue from Germany, where resident investors are taxed at par with non-resident investors.
In addition to the above, the CGT regime also metes out differential treatment to gains arising from on-market transfer of listed equity shares and off-market sale of equity shares. Under the current regime, short-term capital gains (STCG) arising from on-market sale of listed equity shares is taxable at 15%, while STCG arising from sale of off-market listed shares or unlisted equity shares is taxable at applicable tax rates ranging from 22-40%, in case of corporate taxpayers. Further, for individual taxpayers, the applicable surcharge on STCG arising from off-market sale of equity shares can go up to 37%, as against 15% for on-market sale. Such disparity in capital gains taxation accruing from sale of shares in the private and public market is not seen in any leading jurisdiction, be it the US, Singapore, UK, etc.
Another aspect that needs to be looked into is the determination of holding period of different assets, depending on the nature of securities. Currently, gains arising from transfer of listed securities are regarded as LTCG if such securities have been held for more than 12 months prior to the transfer. However, in case of unlisted shares, such holding period is 24 months; while for other assets, it is up to 36 months. To add to the complexities, units of business trust—Reits (real estate investment trusts) and InvITs (infrastructure investment trusts)—have a 36 months’ holding period. While such units of business trust are treated akin to equity instruments and even under the extant CGT regime, such units and equity shares are taxed in a like manner, the beneficial period of holding applicable to equity shares has not been extended to them.
Conclusion
Such convoluted provisions not only create confusion among taxpayers and result in unnecessary litigation, it also dissuades investments and business opportunities in India. To simplify the regime, the government may look outwards to capture the best practices in other jurisdictions and accordingly introduce changes that are suitable for the Indian market. While stakeholders are excited about a possible new streamlined CGT regime, one will have to wait and watch for what the Budget unveils on 1 February!
Kunal Savani is a partner; Bipluv Jhingan is principal associate; and Vihit Shah is an associate at Cyril Amarchand Mangaldas