Capital Gains, Capital Pain

THE INDIAN GOVERNMENT collected tax revenue of Rs 98,681 crore in FY24 on account of long term capital gains (LTCG) on listed equity shares held for more than 12 months.

- Minhaz Merchant

This accounted for less than three per cent of India's total tax revenue in FY24 of over Rs 34 lakh crore.

Given the tiny share of LTCG in total annual tax revenue, why does the government not consider the merit in abolishing LTCG? Instead, the 2024 Union Budget increased long term capital gains tax from 10 per cent to 12.5 per cent. The incremental tax gain: a puny Rs 25,000 crore.

In principle, when equity shares are held for less than a year, they are termed short-term investments and profits are rightly taxed at an assessee's applicable income-tax slab.

Long term capital gains was first abolished by the Atal Bihari Vajpayee-led NDA government in 2004. The Kelkar Committee set up by the government argued that taxing equity shares held as long term investments for over a year was counter-productive. The Finance Act, 2004 added Section 10(38) in the Income Tax Act, 1961. It exempted long term capital gains on equity shares and equity-oriented mutual funds. The Act, passed in February 2004 by the Vajpayee government, was welcomed by the stock market.

Between February 2004 and February 2018, the Sensex rose from 5,000 to 35,000 - an increase of 700 per cent in 14 years at a compounded annual growth rate (CAGR) of 14 per cent.

The 2018 Union Budget surprisingly revoked Section 10(38) of the Income Tax Act that in 2004 had exempted LTCG from tax. Between 2018 and 2025, the Sensex has doubled from 35,000 to 75,000 in seven years but at a CAGR of just 10 per cent.

There were mitigating factors in both periods under examination. In 2004-18, the sub-prime financial crisis of 2008-09 roiled global stock markets, including in India. Similarly, in 2018-25, the Covid pandemic disrupted stock markets. Nonetheless it's clear that the re-introduction of LTCG on equity shares in 2018 dampened the market's growth.