The government is discussing whether to increase the time limit for applicability of long-term capital gains tax from one year to three years, top consultants and government officials told ET.

The debate revolves around whether the definition of 'long-term' should be raised from one year to three years — a change that would force investors to hold on to their bets for three long years to escape tax. Today, gain on a listed security is taxfree for both retail and institutional investors — if a stock is sold a year after its purchase. If this period is changed from one year to three years, investors would end up paying 15 per cent tax on such exits made before three years.

While many feel this could further dampen sentiment in a volatile market grappling with global imponderables, there are ministry mandarins who think that investors would eventually learn to live with it after initial hiccups. "Why stock market investors should be treated differently?" asked a person close to the development.

"We are not talking about taxing someone who is earning Rs 2 lakh per annum, but someone who is making crores. I am sure they can pay some tax to the Indian government from their huge pool of profits from buying and selling shares," he said.

According to the people close to the development, the change could come as early as in the upcoming budget. To this effect the finance ministry officials have been seeking feedback from economists, analysts, tax consultants and industry experts around this proposal.

Another person who heads one of the top multinational consultancies in India told ET, "There are many global economies even in the developed world where 'long term' is three years. If India has a good macro story, investors ..

Yet, this argument may not cut ice with many foreign and retail investors. "While there may be proponents of the argument that one year is too short a definition of 'long term', any proposal to change this period should factor in investor sentiment, especially at a time when there is a strong impetus to attracting more capital for infrastructure and growth," said Gautam Mehra, leader, tax and regulatory, PwC India.

Industry trackers say that the issue arose after representations were made that investment in unlisted companies be treated on a par with those in listed space. By that the contention was that there would be no tax on investments in unlisted companies if the investment is held for a year.

"The industry wants the government to clarify the law for unlisted shares and explicitly reduce the holding period for unlisted shares from 3 years to 1 year," said Rajesh H Gandhi, partner, tax, Deloitte Haskins & Sells."Given that market participants are acutely sensitive to tax policy changes, any review of the policy should be calibrated, backed by a broader medium to longterm policy objective and should follow extensive stakeholder consultation," said Sameer Gupta, partner and leader, financial services, tax and regulatory.

However, for foreign portfolio investors there could still be a way around. "While domestic investors may be helpless, FPIs and other foreign investors could be tempted to set up operations in tax-friendly jurisdiction such as Mauritius and Singapore and invest from there to avail capital gains tax exemption under the treaty," said Gandhi.

Currently India has a double taxation avoidance treaty (DTAA) with Mauritius and Singapore, which effectively means investors coming through the route are exempted from most taxes. Though this too may be nearing to an end due to the changing regulatory environment in India and globally.

"With the advent of GAAR (general anti avoidance rule) and developments around BEPS (base erosion and profit shifting), it may get more difficult for foreign investors to qualify for treaty protection around such capital gains tax as well," said Mehra. While BEPS is a global framework which India is set to adapt beginning April this year, GAAR is a tax related framework unique to the country.

ET View: Piecemeal Reform Won't Work

Any reform in the capital gains tax treatment should not be piecemeal. The original Direct Taxes Code had proposed doing away with the distinction between short- and long-term capital gains. But it recommended the adoption of a rational approach in the tax treatment of savings to mitigate the adverse impact of capital gains tax. Specify a reasonable amount of savings which is exempt from taxation of current income. Whether these savings are invested in short- or long-term assets must not matter. Exempt the contribution and the accumulation, and tax the withdrawal at the normal income tax rate.