By Sunil Gidwani
Union Budget 2021-22 Expectations: While the Indian economy appears to be getting back on track and capital markets which are seen to be the barometers of the economy seem to show all-time high positive sentiments among the institutional and retail investors, certain tax issues need immediate resolution. One hopes the government addresses these in the budget proposal.
1. Tax collection at sources (TCS) on sale of unlisted equity shares
The Finance Act 2020 expanded the scope of TCS by introducing the provision for TCS of 0.1% on the sale of goods worth Rs 50 lacs or more, with effect from 1 October 2020. The term ‘goods’ is not defined under the provisions of the Income-tax Act and therefore, an issue arises on the applicability of TCS to securities. Though ‘goods’ include securities under certain laws, perhaps the intention was not to cover financial instruments. CBDT had issued a circular clarifying that TCS would not be applicable on the transaction in securities carried out through stock exchanges. This effectively means that TCS applies on sale of unlisted securities which is done outside the stock exchanges, such as unlisted equity shares, units of mutual fund, and units of AIF.
It’s a common knowledge that there is an active market for these securities not only among institutional investors like PE/AIFs and promoters of companies (for pre-IPO allotments, buybacks, etc) but also retail investors and employees who get shares through ESOPs. TCS would mean the buyer pays 0.1% tax even when there is no certainty about timing and ability to sell and whether there will be any profit at all. TCS is alright in normal trade of good because good are bought for sale in the short term but not where securities are illiquid and meant for long term investments.
2. Lower withholding tax rates on dividend income for FPIs
As per the current provisions, companies withhold tax at the rate of 20% plus surcharge and cess on the dividend paid to FPIs, even if they invest from a jurisdiction that provides for a lower rate of 5%, 10%, 15% based on India’s double tax avoidance agreement with that country. This is because the withholding provisions for FPIs is as per Section 196D of the Act, whereas the lower rates are applicable for payments to non-residents under Section 195. Since section 196D is specific for FPIs, benefit of lower rates is not applicable for FPIs. It is important to address this anomaly by amending Section 196D of the Act to provide for withholding of taxes on dividends to FPIs at the applicable ‘rates in force’ instead of 20%.
3. Parity in tax treatment for investments in Unit-linked investment plans (ULIP) of life insurance companies and mutual fund units
Under the current tax regime, ‘switching’ of investment in units from one scheme to another scheme of a mutual fund such as Dividend to Growth or Direct to Regular is considered a ‘Transfer’ and is liable to capital gains tax, even though the amount invested remains in the same portfolio and there is no realized gain. However, the treatment is not same for ULIP and accordingly not subjected to any tax. Also, capital gains on proceeds received from ULIP continue to remain exempt in comparison to capital gains on mutual fund units which is subject to LTCG/STCG. To provide a level playing field among similar investments, capital gains exemption should be granted on such switches in mutual fund units.
4. Streamlining of capital gains tax and period of holding among different securities
Currently, there are different rates of capital gains taxation i.e., 10% and 20% for LTCG and 15% and 30% for STCG depending on the type of security held such as equity, debt, units, etc. and whether listed or not. Further, the long-term period is 1 year, 2 years or 3 years for different types of securities. This leads to a lot of complexities for investors while determining their capital gains tax and adjustment of profits and losses. There is scope for simplification of categories of different securities.
5. Rebate on Securities Transaction Tax (STT)
India is the only country that levies STT and CTT in the derivatives and commodities segment respectively. STT is applied on both sides (buy/sell) in the case of cash equity and only on the sell-side in the case of derivatives. Initially, the amount of STT paid was allowed to be claimed as a tax rebate but this rebate was later discontinued. Its been a long pending demand of the investor community that either STT which was originally meant to be in lieu of capital gains should either be completely removed, or a rebate is reintroduced.
6. Pass-through status to Category III AIFs
Currently, there are no specific provisions governing taxability of Category III AIFs. Typically, these are structured as trusts and the laws governing taxability of trusts are used for determining taxability of Category-III AIFs and their investors. However, category I and category II AIFs are granted special pass-through status and are taxable in the hands of the investors. With increase in surcharge rates for high-net-worth individuals, taxation at the fund level for category III AIFs would lead to a disparity of net tax rates. At the Fund level, surcharge at the highest rate would be applicable which would adversely impact the investors falling in the lower tax bracket but still be subject to surcharge of 37%. A ‘pass-through’ status will ensure fairness in the tax treatment for all investors.
(Sunil Gidwani is Partner, Nangia Andersen LLP. Views expressed are the author’s own.)