Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Capital gains tax

I wrote a piece in yesterday’s Financial Express about the
budget proposal related to capital gains taxation and securities
transaction tax. I wrote that the government seems to have realized
that its decision two years ago to replace the capital gains tax on
securities with a tax on securities transactions was a mistake. My
article makes the following points:

  • The capital gains tax is like a call option on the stock market
    index. If the market rises and people earn capital gains, the
    government gets a share of that gain. When the market goes down, the
    government does not share the loss, it only allows the loss to be
    carried forward.
  • Call options are too precious to be just thrown away but back in
    2004 when “prices of securities were much lower” as the
    Finance Minister points out now, the call option must have looked
    less valuable. Now, the Finance Minister wants to bring back capital
    gains tax in two different ways.
  • The really imaginative solution is to exploit the Minimum
    Alternative Tax (MAT) to achieve a tax rate of 10% without
    indexation which is the same as what foreign investors pay.
  • The cruder solution is to raise the securities transaction tax
    “with a view to raise additional resources and also plug the
    leakage of tax revenue”. In other words, at last the
    government admits that the substitution of capital gains tax with
    the STT is leading to a leakage of revenues.
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