Short-term cap gains tax hurts small taxpayers

Balwant Jain
Give with the left hand and take away with the right. 
The government’s move to increase the short-term capital gains tax to 15% on securities transactions from earlier 10% negates the intentions with which the tax was introduced in the first place.
The securities transaction tax (STT) levied on the transaction of shares and securities carried out at stock exchanges or even on equity-oriented schemes of mutual funds (MFs).
With the introduction of STT in 2004, the government proposed to compensate the taxpayers in respect of the said transactions. Section 111A was introduced to provide for taxation of such short-term capital gains at concessional tax rate of 10%. The government also introduced Section 10(38) where such transactions were exempt from income tax on long-term gains.
This article will touch upon the fact that with the subsequent increase in the rate of short-term capital gains taxation to 15%, the intention of benefiting the taxpayer has been defeated.
Before STT, short-term capital gains on sale of equity shares and units of equity-oriented MFs were treated at par with other income, which was taxed as normal income. Therefore, applicable tax rate varied from one assessee to another, depending on the tax slab applicable to him. However, long-term capital gains have traditionally been given concessional treatment as far as tax is concerned and even with regard to avenues available for exemption by reinvestment of sale proceeds of such assets.
After introduction of STT, the transaction of purchase, sale and redemption of units of equity-oriented MFs resulted in higher transaction costs for the buyers and sellers. To compensate these investors, the tax on profits of such assets was also changed. The revised provision provided for levy of 10% short-term capital gains on these instruments.  However, the long-term capital gains on such assets were exempt from tax.  10% was the minimum tax levied at that time on the income, once your income crossed the threshold limit. The law says that if your other income excluding the short-term capital gains due to sale of shares and units subjected to STT was lower than the exemption limit, then no tax on short-term capital gains will be levied. This is to the extent of difference between the exemption limit and other income. Here, the intention was to levy tax at lower rate even for the taxpayers who fell into the higher tax slabs, but had earned short-term capital gains.
The tax on such short-term capital gains was raised to 15% in April 2009 and the law of unintended consequences followed. Simply put, the intention behind introduction of special rate for such short-term capital gains was partly defeated.
Let us understand this with an example.
Suppose you have total income was `3 lakh including such short-term capital gains of `100,000 during the year ended March 31, 2010. For that year, the income up to `160,000 was exempt. The income between `1.6 lakh to `3 lakh was taxed at 10%. When the STT was not applicable, the short-term capital gains were taxed at a normal rate. Like in case of above example, your tax would have been `14,000 but due to the 15% tax levied on short-term capital gains, your tax will rise to `19,000.
The purpose of introducing the Section 111A was to provide relief to the people who were levied STT on their transactions of shares and securities. However, with this 15% tax on short-term gains, you will pay a higher tax than the minimum applicable. As a result you would suffer, though the provision of Section 111A is supposed to provide relief to taxpayers.
This way we see that if short-term capital gains were not earned on the shares on which STT was paid, you would have been better off.
The Direct Taxes Code 2010 also proposes to allow a deduction of 50% on such short-term capital gains and tax the balance 50% as regular income. Hence, in effect the 5%, 10% and 15% tax will be applicable for the taxpayers in the tax slab of 10%, 20% and 30% respectively. Thus, the effective tax rate of 5% will be applicable for the taxpayers in 10% tax slab proposed in the DTC, as against the 15% being levied currently on taxpayer whose tax slab is 10%.
So when the proposed DTC being only an year away, I urge the FM  to remove this dichotomy in the provision of taxation of short-term capital gains for the marginal taxpayers. They will be thankful if this amendment is done with retrospective effect.
With the 10% slab being applicable from `1.60 lakh to `5 lakh presently, there would be a lot of taxpayers who would suffer due to this dichotomy in the law, which has resulted in additional tax burden.
The finance minister may amend the law so as to provide for 10% tax in case the total income of the taxpayer including such short- term capital gains that does not exceed the first slab of 10%.
Hope the FM is listening!
Balwant Jain is CFO, Apna Paisa, a price comparison engine for loans, insurance and investments. He can be reached at balwant.jain@apnapaisa.com.