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4 steps to boost the market

January 31, 2004 13:09 IST

The market, in spite of its vacillations has been kind to investors. And a vibrant stock market, while important to investors is perhaps more critical to the economy.

Therefore, more than the investors themselves, it is the government, which should be happy with the turn of events. And with an expected GDP growth of 7 per cent, forex reserves of over $100 billion and overall corporate performance improving, the platform can never be better for the government to take certain actions which will consolidate on this good news.

And with the budget around the corner, what better time? So here are a few creases that the authorities should iron out on priority. Taking these actions will not only clear up the anomalies in the system but will also give a fillip to the already galloping market.

Interest on loan taken to purchase equity: deductible?
Leverage forms an important part of the strategy that small and big investors use alike to participate in the market. It lends liquidity to the market, which is one of the most vital ingredients for vibrancy. However, there is great ambiguity in the tax consequence of taking leverage.

Simply put, is the interest paid on the loan taken for acquiring shares as investments deductible for tax purposes? If not, can it be capitalised for the purpose of calculating capital gains?

The culprit is Section 14A, a provision introduced by FA01 with retrospective effect from April 1, 1962. This section basically says that there can be no deduction claimed in respect of any expenditure incurred by the assessee in relation to an income, which is exempt from tax.

In our context, dividends from equity are exempt from tax. Therefore, in view of Section. 14A, any interest paid cannot be deducted from the exempt dividend income.

Is the dividend income really exempt? Yes, it is exempt in the hands of the shareholder but the dividend tax at the rate of 12.5 per cent is paid by the company directly to the exchequer.

This leads to the tricky situation where though the dividend tax does not come out of the pockets of the shareholder directly, indirectly it is he who bears it by way of receiving that much lesser dividend. Ergo, on account of two factors: routing the tax outflow and Section 14A, equity investors are robbed of a legitimate tax break.

That being the case, can the interest be capitalised? The law does not provide any clearcut answer here. There are judgements allowing capitalising of interest but they are in respect of fixed assets and not equity shares. Also, will indexation apply to the accrued interest every year?

If encouraging the equity markets is indeed one of the agendas of the government, addressing this issue, if not immediately, then at least in the Budget is a must.

Can capital gains be saved in these last three months?
Needless to say, a lot of investors would be earning capital gains in the current market. To save tax on long-term capital gains, investors are required to deposit the net capital gains in bonds of NABARD, SIDBI, NHAI, NHB etc. within 6 months from the date of sale or transfer.

That means an investor earning capital gains in say late February, technically has till August to make the investment and save tax. However, the last date for filing returns for most of the assessees is by July 31.

To remedy such difficulties, the Act has provided for deposits in 'Capital Gains Accounts Scheme, 1988' for enabling the assessee to claim exemption from tax on capital gains under Sections 54, 54B, 54D, 54F or 54G.

The amount deposited in such an account before the due date of furnishing returns of income along with the amount already utilised for purchase or acquisition of the various specified assets under the related sections is deemed to be the amount utilised for such acquisition.

Capital gains and Sec 54
The other issue in capital gains is in respect of Section 54, which grants exemption from tax on capital gains arising out of sale (or transfer) of a residential house, self-occupied or not, provided the assessee has purchased within 1 year before or 2 years after the date of sale or has constructed within 3 years after that date, a residential house. The use of the words "a residential house" in Section 54 has created the controversy.

Suppose Mr Mehta sells his ancestral property and earns capital gains of Rs 50 lakh (Rs 5 million). Within the time limits stipulated by Section 54, he buys two houses of Rs 25 lakh (Rs 2.5 million) each. Should he be denied the exemption?

There have been ITAT judgements that argue the case both ways. However, with such large amounts are at stake, how can we expect the assessees to take the risk? Mr FM, if not tomorrow morning, make the change at least this coming February!

Mutual funds: reforms needed
The mutual fund industry, the other vital source for small investors to participate in the capital markets also needs fine tuning. Investors and even MFs themselves have expressed grave concerns about the so called "single investor funds".

A scheme that has a minority of disproportionately large investors and a larger number of smaller investors can go against the interests of the small investors in various ways. Sebi did at last wake up to this issue and did its bit to address it.

As per Sebi, the solution was to come out with an edict that no one investor should account for more than a quarter of a fund's corpus and that a fund must have at least 20 investors.

How much time would India's investor community take to make investments in four different names each holding a tad below 25 per cent of the corpus and getting a few "well wishers" (actually 16 in number) to make a token investment of say the minimum investible amount -- and the party can continue just as before!

For the record, the interest of the small investor is paramount. However, steps taken in that direction have hitherto left a lot to be desired.

Fortunately for us, internal as well as external factors have engendered a vibrant bull market. This "feel good" effect is the ideal springboard for the Finance Minister to usher in urgently needed reforms. Of course, needless to add, it would also make us all "feel better".

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A N Shanbhag