Friday, September 28, 2012

Inequality and Capital Gains Tax structure in India

The capital gains tax structure in India benefits the rich and the upper middle class and tends to increase the inequality in society.

A capital gains tax is a tax on capital gains, the profit realized on the sale of an asset that was purchased at a cost amount that was lower than the amount realized on the sale. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.

For equities, our legislation specifies differential tax rates as compared to rates on capital gains from sale of other assets. As of 2008, equities are considered long term capital if the holding period is one year or more. Long term capital gains from equities are not taxed if shares are sold through recognized stock exchange and Securities Transaction Tax, or STT, is paid on the sale. However short term capital gain from equities held for less than one year, is taxed at 15% (w.e.f. 1 April 2009) (plus surcharge and education cess). Many other capital investments (house, buildings, real estate, bank deposits) are considered long term if the holding period is 3 or more years. Short term capital gains are taxed just as any other income and they can be negated against short term capital loss from the same business.

Among the sale of various asset classes the sale of stocks in positively discriminated against. The definition of long-term is discriminatory in that stocks held for an year are considered long-term while other assets need to be held for at least three years to be considered long-term. The rate of taxation on long-term capital gains from other assets is 20% while a long-term gain from stock sale is not taxed. The discriminatory treatment continues for short-term capital gains. Short term capital gains from other assets are taxed at normal rates while short-term gain from sale of stock is taxed at 15%.

The participation of retail equity investors in India is abysmally low. The presentation made by Dr.N.C.Maheshwari[1], President of the Association of National Exchanges Members of India, has states that only 1.3% of the country’s population participates in the Equity market (2010). 

Latest Year Available
%of population
(Source: URL in the footnote)

Retail investors began participating in the stock markets in a small way with the dilution of the FERA in1978 and over the next few year participation increased on account of increasing transparency on account of introduction of technology in the operations of stock markets and other factors. Retail investors’ share in the market was 16.5 per cent at the end of March 2009, but has been declining since.

It is evident that the percentage of population participating in the stock market is extremely low and the benefits of low taxation on capital gains are flowing to only a small number of the rich.
The moneylife has interesting article[2] on the issue of low participation of retail investors in the stock market. I quote verbatim here

The SEBI chief is worried about poor retail participation. …
The Securities and Exchange Board of India (SEBI) has finally woken up to the fact that it has fallen short in its key role to develop the capital market and increase the base of investors. Today, SEBI chief UK Sinha admitted as much, saying that the market regulator would take steps to get retail investors back into the market….

In India, the retail participation in the stock market has declined from 20 million in the 1990s to 12 million in 1999, and just around 8 million in 2009, according to official data, this despite the fact that the Sensex has grown by 20 times during this period. As a percentage of the total population, the retail investor participation is just 1.3%, whereas in the US and China it is 27.7% and 10.5% respectively, according to the Bimal Jalan Committee report. The SEBI chief has targeted an optimistic figure of 8% for retail participation in India. 

In August last year, Union minister of state for finance, Namo Narain Meena, revealed in Parliament the reality of the Indian 'equity cult'. He said around 50% of the cash market transactions on the National Stock Exchange (during April-June 2010) came from a shockingly low 451 investors, of whom 156 were proprietary traders, while 50% of the trading in NSE's derivatives segment came from just 106 investors of whom 58 were proprietary traders. Only 6% of client accounts contributed to 90% of the trading in the cash segment. 80% of turnover came from just 41,654 investors. In other words, 1,50,546 investors (78%) accounted for just 10% of trading turnover.

Evidently, most of the stock market operations and the profits flowing there from are benefit only a negligible minority of the population thereby increasing the wealth of a negligibly small rich population. This has an impact on increasing inequality in society. The middle class usually has access to other asset classes like property, gold etc. Capital gains on these asset classes are taxed at rates higher than normal rates applicable for salaries. Hence the system has the effect of taxing the rich at a less rate and the poorer at a higher rate.

Hence, I feel that capital gains should be taxed at higher rates than presently taxed, especially those that accrue from the stock sale.


1 comment:

  1. Interesting one ..
    Media lashes out on subsidies for Gas cylinder ( I am not for any subsidies for people making 250k / year ) , but doesnot complain about LT Capital gains on shares. If somebody can publish, how much money we loose with this as campared to other subsidies geared for poor, it should be interesting. Corruption because of subsidies is different animal to be tamed.