As we get closer to Budget 2018, there are high expectations from the government to rationalise tax rates and simplify the tax system. The US tax reforms and significant lowering of tax rates there have added to the chorus.
On the flip side, investors still remember the honourable PM’s statement of December 2016 where he had indicated that since market participants are not contributing enough to the exchequer. So we need to wait and see if the Budget introduces any additional burden on capital market investments.
Further, in view of not-so-buoyant tax collections and no significant increase in tax base, the government may not have much room available to lower the tax rates.
From the foreign investors’ viewpoint, the key tax changes being discussed are: a) bringing long term gains from sale of equity shares on stock exchange under the tax net; and b) abolition of dividend distribution tax.
The underlying rationale for removal of exemption for long-term capital gains seems to be that it is unfair and favours the rich.
However, one should also consider that the objective of the exemption is to promote development of Indian capital markets by encouraging foreign as well as domestic investors to remain invested in equities for a longer period.
Going by the growth in equity investments in the country over the years both by foreign as well as domestic investors, it is evident that the measure is paying off.
In fact, this tax exemption is one of the key enablers in Indian mutual funds being able to attract close to US$ 1 billion every month last year from Indian retail investors in the form of SIPs (systematic investment plan).
Thanks to the bulging Assets Under Management (AUM) of Indian mutual funds, Indian capital markets are to an extent insulated from any major sell-off by foreign investors.
If the long-term exemption on sale of equity shares or equity-oriented mutual funds is indeed removed in this Budget, investors could look at other investment avenues. In that case, equity indices may find it difficult to scale newer highs or even maintain at current levels.
Even if it is felt that that the exemption has achieved its objective, the government can also consider restricting the long term exemption on listed shares by increasing the holding period threshold from 12 months to 24 months.
Also, for the sake of tax certainty, it is imperative that any change in the long-term exemption should be prospective and therefore should not impact current investments.
The expected abolition of dividend distribution tax would reduce the effective tax rate for Indian companies and increase the dividend pay-outs to shareholders.
Companies could therefore be encouraged to pay out more dividends which will be taxable in the hands of investors as per their income slab, instead of the flat tax rate of 20.36% in all cases.
Individual shareholders whose income is below the taxable threshold as well as shareholders in exempt category e.g. Mutual Funds, Life Insurance Corporation of India, would in fact enjoy full exemption from dividend tax.
Foreign investors in particular would benefit on two grounds. Firstly, because of lower tax rate as per the tax treaty between India and the country of investor’s residence and secondly, availability of tax credit in their country of residence because of withholding tax on dividend. Having said that, abolishment of DDT could be detrimental to the exchequer to some extent.
Amongst other expectations, industry is hoping for simplification of the tax framework for category 3 Alternate Investment Funds (AIF) and abolishment of indirect share transfer tax for category 3 FPIs.
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