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Rediff.com  » Business » Why Hasmukh Adhia is so wrong on LTCG tax

Why Hasmukh Adhia is so wrong on LTCG tax

February 14, 2018 08:29 IST

To say capital gains from stocks are effortless shows little understanding of the treacherous investing terrain, says Debashis Basu.

Illustration: Uttam Ghosh/Rediff.com

A few weeks ago I wrote that the question whether long-term capital gains (LTCG) from equities should be taxed needs to be based on principles of public finance well-articulated and publicly debated, not based on gut feel.

 

I forgot to add the various other ways taxation and tax rates are set in India: Moral opinions, personal bias, or simply wrong conclusions from data.

On February 1, the Union government imposed a 10 per cent tax on long-term capital gains -- mainly on equity funds and share purchases made after February 1, 2018, and, to some extent, on previous purchases.

As it happens with most decisions, the explanation or principles behind this were made available to the unwashed masses, not through any well-articulated white paper but through sound bites.

In fact, it became clear when Hasmukh Adhia, finance secretary, shared his thoughts with the media.

Here are some of his thoughts, or “principles” if you can call them, followed by my comments:

We cannot have a completely different, and sweet, dispensation for one type of capital gain vis-a-vis others. This tends to skew investment and people prefer an option where there is no tax.

This argument is intuitively correct and practically wrong.

In an interview in 2014, Ashish Kumar Chauhan, managing director and chief executive officer of the Bombay Stock Exchange, pointed out that only 2 per cent of people in India invested in stocks and the number of investors had remained the same over two decades.

By the way, Mr Chauhan has been an enthusiastic supporter of taxing long-term gains from equity.

According to the government data until 2014, the average Indian household held 77 per cent of its assets in real estate, 11 per cent in gold, 7 per cent in durable goods such as a vehicle or inventory for a shop, and just 5 per cent in financial assets.

An overwhelming amount of that 5 per cent was held in fixed-income products like bank and post office deposits and provident funds.

Clearly, the tax-free status of equities since 2005 has never been a deciding factor in determining where savers would invest.

It would take multiple articles to explain why, delving into behavioural science.

The lesson: It is important for policymakers to acquire specialised knowledge, not to depend on their intuitive sense and gut-feel.

The FM mentioned Rs 3.67 lakh crore capital gains accrued last year.

Suppose this was the salary income of people, it would have been taxed at 20 per cent or 30 per cent.

This is a gain which is not accruing from any effort, but is just an investment gain.

There are two issues here. One, the finance secretary is all excited at the thought of being able to take a bite out of the Rs 3.67 lakh crore gain.

The finance minister has budgeted an LTCG gain figure of Rs 200 billion (Rs 20,000 crore) for 2018-19.

But there will be LTCG if only most stocks end up higher than they were on January 31.

Mr Adhia’s interviews will make sure that there will not be much gain to tax.

The second issue is his characterisation that investment gains are not a product of any effort.

This comment has riled people, who have expressed their views in social media.

Rajeev Chandrashekar, member of the Rajya Sabha, pointed out “but you are wrong in signaling to the world that long-term investing involves no ‘effort’ -- there is difference between speculative trading and long-term investing. There is lot of ‘effort’ in latter, FYI!”

T Mohan Das Pai, former chief financial officer of Infosys and a staunch supporter of most of the Modi government’s policies, wrote: “Millions of retail investors have come in mutual funds in last two years … they will suffer most for tax on LTCG … Mood is very bad. Please relook, please talk to retail investors, very upset!”

To make money from stocks, investors have to understand businesses, judge management quality, make some estimates about growth, negotiate the tricky issue of reasonable valuation, and finally manage their own emotions since stocks and equity funds are volatile and we humans cannot deal with volatility.

It’s a huge and complex effort.

No wonder, most retail investors find it very difficult to make money in stocks on their own.

This is why they are willing to pay heavily for subscription fees, books, training programmes, and lecture sessions.

People travel to Omaha to acquire wisdom from Warren Buffett of Berkshire Hathaway, precisely because he seems to make it all so simple what we find so difficult.

To say capital gains from stocks are effortless shows little understanding of the treacherous investing terrain.

The moment we equalise the long-term and short-term treatment for all asset classes, there will be no case.

We should attempt in that direction so that your investment becomes tax neutral, your choice of investment becomes tax neutral.

This policy approach is again intuitively attractive but flawed.

Before Mr Adhia rushes to implement this, can he please explain why people have been putting most of their savings in gold, bank deposits, real estate, and insurance all these years, even though returns from stocks require “no effort” and are tax-free?

Debashis Basu is the editor of www.moneylife.in

Debashis Basu
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