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Tackling income tax exemptions for equities and agriculture
January, 05th 2017

The recent statement by the Prime Minister, at the inauguration of a securities markets training institute, that the securities markets were not contributing their fair share of the taxes, sparked off speculation of withdrawal of the long-term capital gains tax exemption and increase in rates of short-term capital gains taxes on stock market share transactions.

While the finance minister was quick to clarify that there was no proposal to remove the exemption for long-term capital gains, one certainly needs to examine whether there is a case for phasing out of such exemptions.

One of the points being made is that most exemptions for companies are already being phased out. Also, this exemption is being misused by penny stock operators to convert black money, through manipulation of prices of penny stocks, and hence needs to be eliminated.

What is lost sight of is that every exemption that has been provided in the past, has been misused by some taxpayers. A classic case was that of various film stars setting up hotels and poultry farms in the 1970s and 1980s, when there were exemptions for profits of such businesses.

Today, now that the exemption is no longer available, how many film stars own poultry farms or hotels? Every tax exemption will always attract taxpayers seeking to use it to convert their black money. What is required is proper monitoring to check misuse, and not elimination of the exemption altogether.

One also needs to remember that the Securities Transaction Tax (STT) was introduced simultaneously with introduction of this exemption.

The objective was to collect at least some tax from foreign institutional investors, who paid no taxes in India at all on their share trading profits. Such collection from STT was to offset the tax loss on account of the capital gains exemption.

Reintroduction of capital gains taxes while retaining STT would amount to a double taxation—retaining the new tax, while bringing back the old tax.

Maybe, in a couple of years, once the capital gains from such investors are no longer exempt under the Mauritius and Singapore tax treaties, STT can be withdrawn and capital gains tax on shares reintroduced.

Speaking of exemptions, the biggest exemption (and correspondingly, the provision subject to the largest misuse) is that for agricultural income. One hears of so many cases of politicians and others who have laundered their money by showing it as agricultural income.

Since most transactions of sale of agricultural produce at the farm level take place in cash, it is very easy to manipulate the quantum of agricultural income.

If the intention of the government is to launch an all-out attack on black money, does it make sense to retain the biggest loophole which enables easy conversion of black money?

The government has taken many steps in the past 2 years to unearth black money, and prevent its proliferation. These include action against persons found to have undisclosed foreign bank accounts or assets, introduction of the Black Money (Undisclosed Foreign Income & Assets) and Imposition of Tax Act, 2015 and the Income Disclosure Scheme 2016, amendment of the Benami Transactions (Prohibition) Act and the demonetization of high-value denomination notes.

One would have thought that the next natural step would be to curb this practice of easy conversion of black money.

The argument against taxing agricultural incomes is that most agriculturists are poor, and that agricultural incomes are still subject to the vagaries of the monsoon and other climatic events.

However, in any case, a poor farmer will not have to pay income tax, if his net income is below the taxable limit. A special exemption of Rs2,50,000 can also be provided to agricultural income, so that an agriculturist with income up to Rs5,00,000, who can be regarded as a small agriculturist, does not pay income tax.

Apart from this, farmers would get the benefit of carry forward of losses from a bad year to the next good year. This should provide sufficient protection to farmers against the vagaries of climate.

One of the points made out by the government—with reference to our taxation system—is that India’s direct tax collection as a percentage of GDP is low, or that the ratio between direct and indirect tax collections is low, as compared to other countries.

In the debate about this, the point is usually overlooked that a significant part of our GDP (around 15%), that from agriculture, is exempt from tax.

Were the government to tax agricultural incomes above a threshold, we would definitely see a significant improvement in these ratios.

One understands that this would require a constitutional amendment, as currently the powers to tax agricultural income lie exclusively with the state governments, and which are not exercised by most of the states.

This government has shown that it has the capacity to get constitutional amendments passed, though after some delay, as in the case of the amendment for Goods and Services Tax (GST). Once the GST issues are out of the way, the next item on the agenda should be the taxation of agricultural income.

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