Clarity & stability

Over the last few years, we have seen tax rates at the individual and corporate levels stabilising at near-realistic levels. In earlier years, indirect taxes on individual items such as the excise duty on ball- bearings  and pressure cookers  would be tinkered with every year.

With this tendency becoming a thing of the past and  stable tax rates coming in, the Budget has almost become a non-event. In response to the world crisis, the two FMs - P Chidambaram and Pranab Mukherjee — have provided stimuli to sustain the economy through lowering of tax rates and reduction of excise duties .

This has had the necessary effect and Indian industry has been buoyed up with the GDP growth in 2008-09 at a healthy 6.7%. Growth in the current year is expected to be above 7.5%.

One side effect of the steroid therapy has been the inflation problem, with food inflation at over 17%, and the RBI expecting inflation at the year-end to be at 8.5%. The fiscal deficit is also expected at an unacceptable 6.8% level. The Budget is expected to taper off the dosage of the drug therapy.

One hopes that the stimulus withdrawal will be caliberated so as to not send the patient who has just shown signs of revival, downhill.

The market has, over the last three decades, had much to be thankful for. Pranab Mukherjee in the 80s had removed TDS on dividends up to Rs 1,000 and in the following year, raised this limit to Rs 2,500.

Long-term capital gains are treated at concessional rates over the years. In the Budget for the year 1997-98, P Chidambaram made equity dividends totally tax free in the hands of the shareholders, while levying a tax on the dividends paid out by companies.

Earlier, a long-term asset was defined as one that had been held for a period of at least five years. This was reduced to three years  and further altered to one year,  where it stands today.

Earlier, short-term capital gains were taxed at the marginal tax rate. This has been changed and the tax rate for short term gains is a concessional rate of 10%. The rationalisation of capital gains taxes was made possible by a simultaneous introduction of STT, ie, securities transaction tax.

This has made life easier for both investors and the exchequer. The income tax department gains more through STT than it has lost through rationalisation of capital gains. The market hopes that the FM would not tinker too much with the current equity market tax regime.

Additionally it is hoped that there would be some clarity on what distinguishes short-term gains from speculative gains. There is a lot of litigation about income from securities held for long-term being taxed as business income.

Short-term gains, ie, those of holding period less than one year, are taxed at a rate of 10%. But, some of these can be rightly classified as being speculative in nature. Speculative gains are on futures and options transactions and are rightly taxed as business income at the marginal tax rate of 30% plus surcharge.

The dilemma arises in delivery based transactions which are short-term. The income-tax department has a long list of criteria to distinguish between short-term gains and speculative gains.

The investor is not sure till his assessment is over whether he will be taxed at 10% or 30%. Common sense demands that the investor should know before hand what his tax liability is. The market expects that the FM settle this issue through the Budget.

All F&O transactions should be classified as speculative. Delivery transactions of holding period less than one month should be also classified as speculative. Transactions between one month and one year should be classified as short-term, eligible for the concessional tax rate of 10%.

All income from securities held for more than one year must be taxed as capital gain and not as business income.  The market also expects abolition of surcharge and also reduction in STT rates.

After independence, we had C D Deshmukh as finance minister from 1950 to 1956 whose stint as the RBI governor earlier made him a prudent and humane finance minister.

T T Krishnamachari in his two innings as FM took the advice of Nicholas Kaldor, an economist of Hungarian origin who had settled in the UK. He brought in the savage concept of taxation from the cradle to the grave.

In addition to income-tax and surcharge, was added wealth tax and, so that taxation continued even after death, estate duty was introduced. Where there was property and little income, property would have to be sold to meet estate duty liabilities.

The rates were played about reaching a peak under Y B Chavan in the mid-70s when the income-tax rate was pegged at 85% with a 15% surcharge, making a total of 97.75%. Wealth tax was charged even on property which had no running income.

Shares also carried wealth tax and with dividend yields being lower than the wealth tax rates, a man would have to sell portions of his shareholding to meet his wealth tax liability on them.

This had its impact on industrial growth as also on public morals and led to the cult of black money, even among otherwise honest people. Since then, tax rates declined, especially since 1984 when Rajiv Gandhi became the PM.

The real reform began in 1991 when India’s foreign exchange reserves reached their nadir and India was on the brink of a default.

Manmohan Singh began reforms with a commitment to decrease taxes every year starting a growth story for the country . With taxes reaching reasonable levels, stability came about, and capital market-relevant taxation has become sensible and stable. With no micro-tinkering and only changes in the benchmark rates, the Budgets have become simple and short.

For the capital markets, the event no longer leads to earth shaking changes.

The writer is chairman and managing director of Motilal Oswal Financial Services