TV Somanathan, Finance Secretary, says the message to the markets is that long-term investments in the share markets are very important for the economy and they continue to be encouraged. They will be taxed moderately as is necessary for every form of income. And there will be less differential between one form of long-term investment and another form of long-term investment between say listed and unlisted, say between listed shares and listed REITs, etc. But the second issue is that there is a marginal signal in favour of long-term versus short-term, which is why the short-term rates have gone up more and the STT on derivative transactions has gone up. The government would like to encourage longer-term investment.If I may start with a very basic question, when the government has increased tax on equities, is it because you need to increase revenue or is this about the balancing act when it comes to all asset classes? What was the prime motive or thought?
TV Somanathan: Policy changes of this kind are not unidimensional. The primary motivation was to simplify the tax structure which we were told in the feedback that we got during consultations on the budget was exceedingly complicated. There was one rate for listed equity, a different rate for listed REITs, a different holding period for some things, a different holding periods for other things and there was a widespread request for simplification. So, the primary aim here is simplification and you can see that that has happened in terms of reducing the number of rates, reducing the differences in classification between one kind of asset and another, whether it is one year to two years to three years in some cases. So, simplification is one, in fact, the primary objective. But increasing revenue collections is also an objective and particularly in the case of the listed equity space, it is an attempt to do a rationalisation but do it without revenue loss.
There is a slight increase in the case of listed equities for the long term and a substantial increase for the short term. For other asset classes such as property and gold, our opinion for the majority of taxpayers is that this is slightly beneficial and in aggregate tax neutral. So, we do not expect any additional collections of taxation from property, gold, or from those classes of assets. Between listed and unlisted securities, it equalises the rate. It retains a difference of one year for listed and two years for unlisted. So, it is both a simplification and a modest increase in taxation in certain categories.
The government has always had a stated objective that they want to increase financialisation of assets. Savings should move into more productive assets. Is the stated intent still on or do you think equities as an asset class now are at comfortable levels and you do not want the penetration to increase?
TV Somanathan: No. There is no change in our stand in terms of not wanting money to flow into equities. However, equities are not the only financial class of assets. There are listed equities. There are alternative investment funds. There are fixed deposits. There are insurance policies. There are many forms of financial investment and there needs to be a balance between the different kinds of financial investment.
Our objective is there must be moderate taxation with simplicity minimum complications and minimum chances for evasion and tax arbitrage. So, this is the wider objective.
The Indian stock market participants have to pay STT, they have to pay tax on dividends and now there is an increase in taxation. A lot of taxes.
TV Somanathan: Please tell me which well-developed capital market in the world does not have taxation of dividends? Which of them does not have taxation of capital gains? Yes, we have a moderate STT and we have a very moderate rate of capital gains taxation in comparison to the very developed financial markets with whom India is very legitimately happy to compare itself with. We consider ourselves a world-class capital market and when I look at the world-class capital markets in New York or London or other such well-established financial hubs, I find capital gains taxes are much higher, I find that dividend taxation is universally present and that they still develop into very thriving financial locations and they have developed into these locations over an era where they had all these taxes.
My next question is that the rate of 12.5% is an odd number, but will the number stop here or is this just an indication because six months down the line the next budget is coming? Has a new rate cycle started?
TV Somanathan: It is not our intention to start any new rate cycle. This is a unification of rates of different asset classes. We calculated that this rate would be broadly neutral for the other asset classes which were on a regime of 20% with indexation. So, it was our calculation particularly for the unlisted property and other assets that if you remove the indexation benefit, the effective tax was something close to 13% to 14%. We chose to go a little lower, for a round number that could be unified with listed securities. So, there is no intention to go further.
The last time the government moved on long-term and short-term taxes, was in 2018 under Mr Jaitley’s leadership and it has taken almost five years before the next move was made. Can I assume that this move should be looked through a similar kind of lens that the government has increased taxes, now they will observe it, they would look at the numbers, and then perhaps decide on it. They will not be in a hurry.
TV Somanathan: I am being very clear. We are not looking at this as a measure for six months. This is the unification that we have wanted to do. We have done it. There is no intention to change this in the short run. Now, why am I saying short run? Because it is not for me to say what will happen in the long run. So many things can happen in the long run which I cannot predict. But there is no current intention to go any further.
Real estate has just about started blossoming. Was there any need to change the indexation rules? What was the thought behind it? We just want to understand your thoughts.
TV Somanathan: The thought was simplification. If you try filing an income tax return and if you have capital gains, you have multiple sections of the form. There is one for things with indexation, some without indexation, some at this rate, and some at that rate. This is not what I am saying. This is what we were told by the industry. This is what we were told by taxpayer associations that it is very complicated. And then indexation, for each year you have to do a computation. So, its direction is simplification.
Now, frankly, as a mathematical number, 20% of real and 12.5% of nominal are not very different in high-return assets. In most cases of real estate, we have calculated it will be beneficial because who invests in real estate? If you invest in real estate only for the sake of your own home, then you have a rollover provision there. You do not need to pay tax on your real estate gain. You can roll it over into another house. You can do it for a value of up to Rs 10 crore.
Individual middle-class investors do not even need to pay a tax when they sell their house because there are rollover provisions through capital gains bonds. There are rollover provisions through buying another property, so that is not what we are talking about. We are talking about people who are looking at it as an investment. If you are looking at it as an investment, then what rate of return do you expect from real estate? I presume you are looking for something more than a fixed deposit. So, if a fixed deposit is giving you 7% to 7.5%, I do not think you would buy a property for that rate of return.
So, you are looking at something that is substantially higher, which is 11%, 12%, 13%, 14%, 15%, 20% – anything above 10% and if you take inflation at 4% to 5%, 12.5% is not higher than what you would get. But if you are assuming that property will grow at a very low rate, then perhaps the loss of indexation may result in a higher tax than the 12.5% rate. But otherwise, 12.5% is far lower than 20%. Yes, there is no indexation, but it is 12.5% of a larger gain instead of 20% of a smaller gain. In my rough calculation, if you have a rate of return above 10% and definitely above 11%, then you are better off with 12.5% on the nominal than 20% on the real gain.
I just want to capture the message of the government for the market. Can I say that the reason why long-term taxes and short-term taxes have been changed is largely to simplify the tax structure? The attempt here is not to increase the cost of transactions in the capital market and is not an indication by the government that there is something wrong with the capital markets in terms of participation and price points? Can I summarise that as a message?
TV Somanathan: I would like to put it in a more nuanced way. The message to the markets is that long-term investments in the share markets are very important for the economy and they continue to be encouraged. They will be taxed moderately as is necessary for every form of income. And there will be less differential between one form of long-term investment and another form of long-term investment between say listed and unlisted, say between listed shares and listed REITs, etc. But there is a second issue which is that there is a marginal signal which is in favour of long-term versus short-term, which is why the short-term rates have gone up more and the STT on derivative transactions has gone up. So, there is a sense that we would like to encourage longer-term investment and not so much emphasized speculation through derivatives or speculation through short-term trading in the cash market.
Is the finance ministry worried about speculative action and participation in the F&O market? What is your view?
TV Somanathan: Worried may be too strong a term, but I think the ratio of futures and options trading to cash market trading in India is abnormally high by global standards and it is a concern. However, it is not something that we would like to handle in a heavy-handed manner. Specific measures would be taken by regulators when they feel it is appropriate. But from our side, this is an opportunity to collect a tax on a non-merit activity as we see it.
Let’s look the great success story of the last couple of years – the wealth created in PSU stocks. Once the ugly ducklings and backbenchers, PSUs are cheerleaders now. The market cap and respect PSU stocks are commanding, are all thanks to good work by the government. The valuations and market caps are at a record high. Is this a good time for the government to start indirect disinvestment via the OFS route or via the direct stake sale in the market?
TV Somanathan: The right time to disinvest is something that the government will take a very pragmatic view on. If we had listened and done a lot of disinvestment two years ago, we would have less money now to disinvest. So, the optimal timing is always more apparent with hindsight than in advance. I do not have too many comments on this. My colleague Mr Tuhin Kanta Pandey is in charge of this, of timing our disinvestments and I do not want to pre-empt what he would be doing. If I were trying to do something, I would not want to tell you in advance because I would want to get the best value that I can get.
The Budget has gone down very well and macro watchers are calling it a budget for the bond market and bond markets are delighted. But bond market participants have one question. The numbers for this year are easy to understand, but for next year, how would the fiscal deficit number be met minus the RBI dividend?
TV Somanathan: We have committed to bringing next year’s deficit to below 4.5%. That commitment has been made in 2021, reiterated in 2022, reiterated in 2023, reiterated in the interim budget in 2024 and reiterated now. We are just six months away from the Budget for 2025-26 and that should reflect our seriousness in getting there and our track record is that every time we have progressively moved closer to that number. So, let me tell you that we are committed to bringing the deficit below 4.5% for the next financial year.
How will we do it? There are multiple ways that we can do it. Certain items of expenditure are flexible. Yes, the RBI dividend is a one-off, but it is not necessarily something that will shrink completely next year from its current levels. It may shrink, but if it does, we have other sources by which we are expecting buoyant dividends from the public sector and public sector banks. Certain parts of our expenditure are controllable. For example, we have certain discretionary expenditures on the capital side, the loans we give to state governments – those are flexible. We can adjust them to the requirements and therefore there is enough flexibility for us to attain the objective of a fiscal deficit below 4.5% of GDP and I think therefore there is no reason for doubt on that objective.
I will wrap the discussion by saying that we at ET Now sincerely feel that the Budget estimates are conservative and there could be a big upside on the tax collection side and the fact that this year we are in for a good monsoon and inflation is coming under control, so the macros will ensure that we are in for a positive surprise. Will that be a fair assessment on my part?
TV Somanathan: Numbers are conservative, possibly, but not too much. We have given the fairly large middle class a tax cut on the new system and the new system by the way is now the majority system as we are seeing in the returns that are coming in. So, there is a Rs 17,500 per person tax cut, there is a tax cut on gold in terms of customs duty and so our estimate as reflected in the budget speech is minus Rs 7,000 crore on the tax front. So, is it conservative? Time will tell, but we are confident of reaching our target of 4.9%. Will we do better than that? Let us see.
