Unfair Capital Gains Tax

When Indians invest in the stock market, they are subjected to a variety of taxes (the Securities Transaction Tax, Commodities Transaction tax, Short Term Capital Gains Tax and Dividend Distribution Tax to name a few). While Indians end up paying huge taxes for trading on their own bourses, the FII’s evade these taxes taking advantage of the double tax avoidance treaty that India has signed with Mauritius. The short term capital gains are taxed at the rate of 10% for Indian retail investors. But the FII’s channel all their investments into India through the Mauritius route and evade the 10% tax that they should have paid on their profits. Shouldn’t there be an equitable distribution as far as taxes are concerned? But this case seems to be skewed in favour of FII’s who are the major causes of volatility in the markets. Harnessing the strength of the amount of cash they have at their disposal, they try to run the bourses according to their whims and fancies. The government should try to simplify procedures and tax laws for retail investors to attract these people towards the market. At present, a vast majority of Indians remain away from the markets and the profits are reaped by the foreign institutional investors. Instead of doing this, the government is taxing Indians and leaving the FIIs to take the entire profits earned on Indian soil with them. Shouldn’t the government look at correcting the anomalies with the double tax avoidance treaty with Mauritius? Or it could consider scrapping the capital gains tax for everybody to make the process equitable. This would provide a major relief to the retail investor. The concept of capital gains tax as a whole is flawed. Unfairness of the tax lies in the fact that individuals are permitted to deduct only a portion of the capital losses that they incur, whereas they must pay taxes on all of the gains. That introduces an unfriendly bias in the tax code against risk taking. When taxpayers undertake risky investments, the government taxes fully any gain that they realize if the investment has a positive return. But the government allows only partial tax deduction if the venture goes sour and results in a loss. There is one other large inequity of the capital gains tax. A government can choose to tax either the value of an asset or its yield, but it should not tax both. Capital gains are literally the appreciation in the value of an existing asset. Any appreciation reflects merely an increase in the after-tax rate of return on the asset. The taxes implicit in the asset's after-tax earnings are already fully reflected in the asset's price or change in price. Any additional tax is strictly double taxation.

A large amount of Participatory Notes (PNs) reach India through the Mauritius route. This gives the entities involved enough scope to avoid taxes and even their identity. As a result, money for terrorist activities is increasingly coming to India through the Mauritius route. This is a major security hazard for the country. Disappointingly, the Indian government has relaxed the regulations as far as PNs are concerned. And all this has been done to attract FII’s back into the Indian market. Shouldn’t we look at the long term health of the markets and the economy instead of getting down on our knees for short term gains?

It would be in the interests of national security and retail investors if the government finds the anomalies and loopholes in the current treaty and works on plugging these loose points.

Recession – A Blessing in Disguise

There’s a huge hue and cry about India going into the recessionary phase. The business newspapers suddenly changed tract from a confident, positive tone to pointing to a bleak future. There was a hint of negativity everywhere. But is recession so bad... well I would like to differ.

Ever since the government brought in financial reforms in India, prosperity was bench marked against the GDP growth rate of the country. But the concept of considering the GDP as a reflection of the economic prosperity of the people is in itself faulty. Considering that three-fourths of Indians depend on agriculture for their livelihood, the contribution by agriculture to the Indian GDP is a meager 20%. Contrast that to the 55% contribution by the services sector where the people involved are much less in number. This unbalanced situation led to an increase in the disparity. While less people earned a huge sum of money, the majority of Indians continued to suffer. While India’s GDP was growing at a scorching pace a couple of years ago, the agricultural sector lagged behind. As a consequence, the present recession has affected a small minority. The lives of the vast majority remain unaffected by the trauma unleashed by this recession. A large majority of the population stays away from the capital markets.

Moreover, during the market boom and the bubble that followed, India missed the social growth. According to economic theory, social growth comes before capitalist growth. Since we missed the social factor, the zooming stock market was never recession proof and stable. The capitalist growth that India witnessed during the last decade made everybody coherent in their views that the economy was overheating. It was only a matter of time before it cooled down. Luckily this recession will give the people time to think and take a step forward in a planned and organized manner, much unlike the last time when things were haphazard. The social initiatives of the Central government will go a long way in bringing about social prosperity – a precursor and the backbone of economic prosperity. So next time when India experiences a boom, it will much more prepared and in a better condition to handle all the FDI and the FII inflows flooding the shores of the country. Only when each and every Indian witnesses prosperity, we can look to the GDP numbers and the Dalal Street figures to get a sense about the direction in which the economy is headed.

This recession changed the way I think on a host of topics. It’s not that I prefer socialism over capitalism. But I value one advice I got recently –

Beware of naked capitalist propaganda