Taxation reform has to be holistic

The government reportedly wants to extend to three years the holding period for investments in listed shares to qualify for capital gains tax exemption. This accepts the need to change the present capital gains tax regime but might not be the best way to go about it. It would discriminate against all those investing through Mauritius and Singapore, whose capital gains attract no tax under India’s double-taxation avoidance agreement with these countries. Instead, the government should adopt the novel tax treatment of capital gains proposed in the original Direct Taxes Code proposed by P Chidambaram as finance minister.

It sought to eliminate the distinction between long-term and short-term capital gains on the basis of the period of holding, abolish the securities transaction tax, and include only that portion of capital gains that is not deployed in any other capital asset, as part of taxable income. The principle — to spare the saving asset from tax and charge a tax on income from the asset — is sound, and holds for gains from portfolio churning. So, the government must transit to the exempt-exempt-tax system wherein all savings will be exempt from taxation at the time of contribution and accumulation, and taxed only at maturity. Even at maturity, if the saving is reinvested in another asset, the corpus must be exempt from tax.

Alongside, there is a strong case for sharp reduction in the rate of personal income tax and raising the income threshold that attracts the peak rate of tax. The goods and services tax would, with its multiple audit trails, widen the base of direct taxes, too. Widening the base and lowering the rate should go hand in hand with rationalising the capital gains tax regime. In other words, taxation reform has to be holistic.