Resist Temptation

Raising India's Investor Taxes Will Backfire

A capital-gains levy may look like low-hanging fruit, but it's toxic.
Dhiraj Singh/Bloomberg

Sending investors the bill for a shortfall from India's new goods and services tax is a bad idea. Finance Minister Arun Jaitley should resist the temptation. A long-term capital-gains levy on equity can be problematic in a country perennially short of domestic savings. In a frothy stock market, it's like crying "fire" in a crowded room.

Profits from selling shares that were bought more than a year earlier has been tax-exempt in India for a decade and a half. It was replaced 14 years ago by an imposition on all securities transactions, regardless of gains or losses. Every year, there's talk of bringing back a capital-gains charge. Speculation is unusually intense ahead of the Feb. 1 federal budget, with Deloitte Touche Tohmatsu India LLP calling capital-gains tweaks "low-hanging fruit." 

But from a poisonous tree.

If It Ain't Broke...

India's securities transaction tax earns the government a small but steady sum; replacing it with a long-term capital-gains tax would embrace uncertainty and spook investors

Source: Budget documents

Granted, collections from last year's GST have been lackluster. Evasion may be part of the story; but multiple rates, constant tinkering with slabs and deadlines and complicated filing may be bigger reasons. It may take another year for the tax to stabilize. However, going after stock investors to plug the deficit would backfire.

The securities transaction tax, which is 0.1 percent for both buyers and sellers of cash equity, 1  is easy to administer. While it brings in about $1 billion, a mere 1.5 percent what New Delhi collects on corporate profits, it's a stable source of revenue.

Destabilizing a levy everyone's come to accept, and replacing it with a tax that works only when markets go up, is pointless tinkering. The benchmark index is within striking distance of its peak price-to-earnings valuation of 19.5 -- there'll be nothing for Jaitley to collect in a falling market.

Most brokers agree that reimposing the capital-gains tax could push down the stock market. Should negative sentiment persist, the government may find it hard to speed up asset sales. State-run banks, too, would struggle to raise the equity they need to boost their degraded lending capacity. Unless Jaitley garners at least $10 billion from sales of state assets, and another $8 billion from auctioning telecom spectrum, the burden of state subsidies plus the extra interest  he'll have to pay on recapitalization bonds (being issued to mend the broken balance sheets of government-owned lenders) would fall on additional borrowings. That might displease bond vigilantes.

Elephant in the Dragon's Shadow

A decade ago, they were roughly similar-sized. Now China's stock market is 3.5 times India's

Source: Bloomberg

*Market capitalization as a percentage of world market capitalization.

Rather than reintroducing long-term tariffs, India needs to review some of the harsher short-term levies.

On current plans, dollar-denominated futures contracts on Indian stocks will kick off in Singapore next month. Already, futures on the benchmark Nifty 50 Index are a big draw in the city-state. Should more foreign investors trade Indian equity derivatives there to avoid a 30 percent capital-gains tax in India, well-paying finance jobs in Mumbai would be at risk.

At a time when Jaitley's No. 1 priority before next year's general election is to boost investment and employment, dismantling a transactions-tax regime that works, only to chase an uncertain pot of gold, would be nothing short of an own goal.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. The rates are different for mutual funds and derivatives. 

To contact the author of this story:
Andy Mukherjee in Hong Kong at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net

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