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.