What's the cost of doing business in India?

Once the dust settles down, the re-introduction of the long-term capital gains tax will not really bother Indian investors.

 |  5-minute read |   31-03-2018
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The re-introduction of the long-term capital gains (LTCG) tax on the sale of listed shares and units of equity-oriented funds/business trusts in the Budget was expected. The newly inserted Section 112A contains the details. The tax rate is fixed at 10 per cent (plus surcharge and cess), lower than the long-term capital gains tax of 20 per cent on other assets, and only capital gains above Rs 1 lakh are exigible to tax. The law would be effective from April 1, 2018. All gains until January 31, 2018, would be grandfathered.

Tax revived

Why has the tax been revived? The tax had been abolished since October 1, 2004, on the condition that the Securities Transaction Tax (STT) should have been paid on the transaction. The government’s reasoning is that making such gains exempt reduces incentives to invest in the real sector.

Distortions are produced in asset preferences in favour of the financial market. This also leads to erosion in the tax base and abusive use of tax arbitrage opportunities. The zero rate was adopted to lure FIIs earlier but that is not the primary aim today. Now the emphasis is investments in manufacturing and services sector and the concomitant increase in investment and employment.

The STT, however, has been retained which had been introduced in lieu of LTCG tax. With a collection of about Rs 9,000 crore this year and much more expected next year, the government is unwilling to let it go. No legal bill can be drafted so comprehensively as to consider every eventuality.

The pitfalls, the controversies, the grey areas only emerge once the bill is in public domain. Expectedly, the details of the provision had led to worries and head-scratching across the community of tax-payers and consultants. There was also at least one instance of a drafting ambiguity which could have led to an unintended tax consequence.

The government took notice of these ambiguities and introduced an amendment to the Finance Bill, which was approved by the Lok Sabha on March 14, 2018. Though some concerns have been addressed, others remain. The first issue is fundamental: how to calculate the tax in certain situations?

The provision stipulates that the higher of the listed price as on January 31, 2018, or the actual purchase price would be adopted as cost of acquisition when the shares are sold from April 1, 2018. Further, if the sale price is less than the listed price as on January 31, then the higher of sale price or actual purchase price will be taken. A reasonable benefit, no doubt. But the problem can arise in the case of a merger.

Suppose after January 31, 2018, the company in which a person holds shares has merged with another company. The existing shares would get extinguished and shares in the new entity would be issued. What would be the cost taken of these new shares when they were sold subsequently on or after April 1, 2018? As per the current law — Section 49(2) — the cost of the shares of the earlier company would have to be taken. Would the old law hold sway and the original value apply? Or would the new formula apply? Equity demands the latter. But the law, if not clearly enunciated in black and white, cannot and should not apply by implication.


Differing views

Else, there may be differing views leading to litigation. The circular issued by the government dated February 4, 2018, mentions that bonus shares and rights shares will be valued as per the new formula but is silent on this issue. The amendment also does not address the problem. The situation becomes iniquitous when an unlisted entity merges with a listed entity. Vodafone India (unlisted) and Idea Cellular (listed) are merging and the deal may close shortly.

If a shareholder of Vodafone wants to sell his shares on or after April 1, 2018, what would the cost price of his shares be? The amendment stipulates that the cost of acquisition of the unlisted shares would be considered and the benefit of indexation (not allowed on listed shares) would be given. This is an inequitable provision.

The fair market value (as per the methodology specified by the government) as on January 31, 2018, should have been adopted. The cost of acquisition even with indexation will shortchange the tax payer because in most cases it will be lower than its inherent value as on January 31, 2018.

Growth and jobs

Another issue is regarding the non-productive transactions that shareholders are making this month. Gains on sale of shares made in February and March this year will not be taxed. The gains nominally earned in February and March will, however, be taxed if the shares are eventually sold from April 1, 2018.

Many investors will be loath to pay taxes on these "book" gains and are selling shares in March (whose prices are higher than prices as January 31, 2018) to avail of the tax-exempt status till March 31, 2018. And since the stock market is in the correction mode, these shares can be re-purchased in April 2018. These transactions do not reflect any underlying commercial substance. Tax relief is the driving factor. The falling Indian markets, among other reasons, are a consequence of the reshuffling of funds before the tax kicks in from April 1.

Tax treaties will still be used to exempt gains from tax. The laws have become strict now regarding treaty benefits thanks to a worldwide recognition of the need to curb treaty abuse. But once the onerous prerequisites have been met, the exemption can be claimed. Once the dust settles down, the 10 per cent tax will not really matter and will be considered as cost of doing business. The distortions between various sectors will hopefully come down and generate more investment, growth and employment.

 (Courtesy of Mail Today)

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Ajay Mankotia Ajay Mankotia @ajaymankotia

The writer is an author, former revenue official and a music aficionado.

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