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Higher tax on capital gains, other passive incomes on cards as mostly rich people get the benefits

By Justin M. Bharucha, Managing Partner at Bharucha & Partners

The 2022-2023 Union Budget lays the roadmap for India@100. During her speech introducing the Union Budget, Finance Minister Nirmala Sitharaman announced initiatives for, amongst other sectors, the ‘7 engines’ of the economy. Although the government has predicted higher revenue recovery in FY 2022-2023 (Rs 19.25 lakh crore) to support these initiatives, given that over Rs 12 lakh crore in revenues raised by the government are being disputed, an increase in tax rates, or the imposition of new taxes, may be required to boost actual recoveries.

This adds to the increasing public commentary on reviewing the capital gains tax regime and, finally, the government seems to be weighing in on the conversation. Reports indicate that the government is considering revamping the capital gains tax regime, particularly with a view to increasing the rate of tax payable on long term capital gains earned from the capital market.

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The government’s interaction seems to be based on the position that passive income from the capital market should not be taxed more favourably than income earned from business as the latter involves greater effort and risk, and facilitates job creation. The proposal may also be borne of a desire to address income inequality as, in February 2022, the Revenue Secretary had mentioned that 80 per cent of long-term capital gains from equity were received by persons earning Rs 50 lakh or more. The narrative seems to be ‘tax the rich’ which is not in itself objectionable and which will, happily for those interested, in turn lend itself to more populist articulation when required.

The broader narrative aside, the position as reported does not stand up to scrutiny. It is at best reductive and overly simplistic; at worst piecemeal and, for that among other reasons, counterproductive. The broad brush categorising of investment in capital markets as non-productive can only be a deliberate articulation of an extreme position. At the least, the government must accept that investment in capital markets boosts productive saving (investment) as opposed to bald consumerism, fuels the growth of investee companies, provides opportunities to a broader range of investors, and moves the economy towards more transparent and compliant transactions.

All of this also ignores the high dividend tax levied in India and other matters of detail (such as gains accruing from securities issued as ESOPs and sweat equity).

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Over the decades deliberate policy decisions have driven public wealth creation towards capital markets. To undo that is, to put it kindly, regressive and an untrammelled digression from the government’s stated principles to establish India as a fully transparent and compliant economy.

That said, it is also clear that income inequality needs to be addressed. However, it is glaringly obvious that merely increasing the rate of tax on capital gains from capital markets is a regressive and, likely, an ineffective step especially if implemented on a standalone basis. In practice this sort of piecemeal initiative may well exacerbate the existing inequity in India where the burden of the direct tax contribution is primarily on individuals with lower incomes as high net worth individuals have the resources and access to methodologies to lawfully minimise their respective liability to tax.

Tax policy should encourage and incentivise work (and history has shown that high rates of direct tax have the opposite effect) and reward compliance. While tax policy should encourage both spending and saving, it should not unduly penalise taxpayers for benefits derived from their savings and, or, investments. Levying tax merely on the basis of income being active or passive is illogical; moreso in context of the larger ramifications the position as presently articulated will likely bring about. Any initiatives must be holistic and deviate from our fine tradition of tossing the baby out with the bathwater.

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If the government nonetheless holds that passive income ought to be taxed at a higher rate simply by virtue of its passive nature, then that principle ought to be applied uniformly to all categories of passive income – e.g. inheritance, gifts from family members, and other passive income which is presently tax exempt. Moreso if ‘welfarism’, whatever that may be, is on the agenda.

All that said, it is (consequently?) likely that the government finally raising these issues in the course of public engagement indicates that larger, sweeping, and, to an extent, disruptive changes to the tax regime are in the offing. The writer believes that we will see increasing indications of this in the course of the governmental (executive and legislator) engagement as we run up to 2024. Assuming that these reforms also address the tax status of HUFs, we may also see a Uniform Civil Code being implemented to this timeline.

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So, the government does need to boost its revenue to meet the goals it has set for itself and addressing income inequality will likely be low hanging fruit which will help it do so. That being so, the likelihood of sweeping changes to the tax regime as it obtains today seem likely – and this dispensation has proved itself willing to act swiftly and without preparatory fanfare (comment reserved on post facto publicity). The writer takes this as given. The real question is: How far will the government go in achieving its aims? Will passive agricultural income also be taxed? Or will that be a step too far? We’ve got a roadmap and are waiting on the route.

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