Short-term capital gains tax faces axe

New Delhi, Jan. 14: The finance ministry is planning to scrap the tax on short-term capital gains arising from the sale of shares and the units of equity-oriented mutual funds.

Top finance ministry officials said a decision on the issue is likely to be taken before next month's budget.

Officials say the move would provide a big boost to the capital markets as the tax break would benefit investors in India as well as foreign funds pumping money into Indian bourses. Officials said the move could not only stop foreign funds from "treaty shopping" ' setting up offices in Mauritius for instance to take advantage of the provisions of that nation's double taxation agreement with India ' but also encourage many of them to set up offices in India.

"The tax (STCG) earns about Rs 350 to Rs 400 crore and causes a lot of litigation … this is one reason why the government is planning to scrap it," officials added.

However, the STCG tax does not apply to cases such as the Vodafone purchase of Hutchison Whampoa's 67 per cent stake in Hutchison Essar in April 2007.

The STCG is levied at the rate of 15 per cent on the gains made from the sale of shares or units of equity-oriented mutual funds that have been held for less than 12 months.

The Shome Committee report, which suggested that GAAR be put off till April 2016, has also recommended the abolition of the tax on short-term capital gains.

The panel argued that the levy of the short-term capital gains tax amounts to a double taxation as it comes on top of the securities transaction tax (STT) that is charged on each purchase or sale of stocks. The STCG earns little revenue for the government and acts as a "tax incentive for treaty shopping", which the General Anti-Avoidance Rules (GAAR) seek to beat.

The STT, on the other hand, is budgeted to yield Rs 5,920 crore this fiscal. It is levied at the rate of 0.1 per cent on delivery-based trades in the cash market and at 0.125 per cent on all other trades.

The Shome report argues that the move to scrap the short-term capital gains tax "may provide a big boost to capital markets and in turn help attract investment".

It is widely suspected that much of the foreign investment through Mauritius is really Indian money that has been illegally parked outside and is being brought above ground as legitimate foreign investment.

Most of this money is channelled through participatory notes (or P-Notes) floated by the foreign institutional investors.

Data from the Securities and Exchange Board of India showed that investments into Indian shares through P-Notes hit a nine-month high at Rs 1.77 lakh crore (about $32.4 billion) last November. P-Notes had fallen to a three-year low of Rs 1.28 lakh crore last May.

P-Notes account for 15 to 20 per cent of total FII holdings in India since 2009.

About 40 per cent of all foreign institutional investments coming to Indian bourse are routed through Mauritius. Foreign direct investment flows into India from the island nation totalled $55.2 billion, about 42 per cent of the total $133 billion during that period.

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