The reforms introduced in the Union Budget 2024-25 aim to simplify the tax system, make it more equitable, and promote long-term investments. (Express file photo by Ganesh Shirsekar)
The recent Union Budget 2024-25 has sparked significant debate and backlash, particularly concerning the increased capital gains tax and the removal of inflation indexation benefits for property sales. While the uproar is understandable, a closer analysis reveals that India’s capital gains tax regime, even after the recent changes, remains relatively moderate compared to other nations. Moreover, the elimination of indexation largely conforms with the practice followed by most countries.
The finance minister proposed notable changes in the classification and taxation of capital gains in her budget speech. Most of these changes simplify the existing provisions. Firstly, earlier, the holding period required to make a distinction between the short-term and long-term capital gains (STCG and LTCG) varied significantly across different types of assets. The new budget simplifies this by setting two uniform holding periods: Twelve months for listed assets and 24 months for others. Secondly, the short-term capital gains tax for stocks, equity funds and business trusts has been increased to 20 per cent (earlier 15 per cent) while long-term capital gains are taxed at a flat rate of 12.5 per cent for all asset classes. Next, the most crucial change has been the removal of indexation benefits when computing taxes for certain long-term asset classes. In response to concerns expressed by many stakeholders, this removal of indexation benefits has been relaxed. Taxpayers have now been given the option of choosing the old regime or the new one. Lastly, the exemption limit for capital gains on certain financial assets has been increased from Rs 1 lakh to Rs 1.25 lakh per year, to provide relief to lower and middle-income taxpayers. Though seemingly stringent, these changes aim to create a more equitable and simpler tax structure.
When viewed through an international lens, India’s capital gains tax structure remains less stringent than perceived. When comparing our capital gains tax to those of other G20 nations, it becomes evident that India’s rates are relatively low. Very few countries in the group, including Australia, Japan, India, US, and Turkey distinguish between short and long-term gains in taxing capital gains. Japan, at 40 per cent (for short term, that is, less than five years), and France, at 30 per cent, have some of the highest capital gains tax rates, while tax rates in other countries lie in the 15-30 per cent range. Canada, South Africa, Indonesia, and the US (for the long-term) treat capital gains as regular income taxed at respective income tax rates. Since most countries’ highest marginal personal income tax rate is higher than 20 per cent, the effective capital gains tax would be significantly higher than the 12.5 per cent now put in effect in India. Countries exempt some amount of gains from taxation. In the case of India, Rs 1.25 lakh a year is exempted; in Canada, 50 per cent of capital gains up to CAD 2,50,000 constitutes a taxable gain, while 66.67 per cent of income above that is taxed. South Africa taxes 40 per cent of capital gains as part of income.
In the 1990s, the Chelliah Committee (chaired by Raja J Chelliah), which proposed reforms in the central taxation regime, recommended granting the benefit of indexation while computing long-term capital assets to offset the effect of price inflation over the period during which LTCG had arisen. This was when inflation had been more than 7 per cent for an extended period. Inflation indexation ensured that only taxes on real gains were being computed, thereby reducing the taxable capital gain. One of the most contentious changes in the budget has been the removal of the inflation indexation benefit, which has now been softened. Critics argued that this move increases the tax burden on property sellers. However, it’s important to note that no other country currently offers indexation for capital gains except for Mexico and Israel. In an environment of high and volatile inflation, indexation of gains is required and justified. The UK introduced inflation indexation of capital gains in 1982, in response to high inflation in the late 1970s, which reached levels well over 25 per cent annually. Without adjusting for inflation, the capital gains tax would effectively tax nominal gains rather than real gains, leading to the confiscation of real assets and causing potential damage to the economy. To simplify the tax system, it was frozen in 1998 and replaced by a tapering system that reduced tax rates based on holding time. Australia, too, introduced indexation in 1985 but discontinued it to simplify tax norms in 1999.
The tax revisions have significant implications for investors and the broader economy. Higher tax rates on short-term gains could discourage speculative trading, promoting more stable and long-term investments. This shift could lead to more sustainable growth in the financial markets. On the other hand, the uniform tax rate on long-term gains, despite the absence of indexation, simplifies tax calculations and reduces the scope for tax avoidance through complex financial manoeuvres. The increased exemption limit for lower and middle-income groups aims to make the tax system more progressive, ensuring that the wealthy bear a fairer share of the tax burden. This change is particularly relevant in a country like India, where income inequality remains a pressing issue.
While the backlash against the capital gains tax reforms is understandable, it is crucial to view these changes in a broader context. India’s capital gains tax rates remain competitive globally, and the removal of indexation aligns with international practices. The reforms introduced in the Union Budget 2024-25 aim to simplify the tax system, make it more equitable, and promote long-term investments. Though challenging in the short term, these changes can potentially create a more robust and fairer economic environment in the long run.
Srinivasan is a research associate and Mohan is the president emeritus and distinguished fellow at the Centre for Social and Economic Progress (CSEP). Views expressed are personal
© The Indian Express Pvt Ltd
First uploaded on: 19-08-2024 at 18:08 IST
