India is preparing an overhaul of its direct tax laws to replace a byzantine matrix of rules and help Prime Minister Narendra Modi reduce widening income inequality if he returns to power next year, according to people with knowledge of the matter.

At the heart of the rework is potential increases in capital gains taxes for top income earners, the people said, asking not to be identified as the details are private. For instance, while India levies a tax of as much as 30 per cent on income, it taxes gains on certain asset classes such as equity funds and stocks at a lower rate. 

This isn’t progressive and goes against the principle of equity, said one of the people. A panel may be appointed to build on proposals submitted to the Finance Ministry in 2019 with an eye to implement in 2024, though no final decisions have been made, the people added.

A Finance Ministry spokesman didn’t immediately respond to an email seeking comments. The benchmark stock index fell as much as 0.6 per cent in Mumbai after the report.

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India’s reliance on indirect taxes—levies on consumption — rather than direct taxes on capital is often cited by economists as the main culprit behind the country’s poor getting left behind even as the nation minted 70 new millionaires each day between 2018 and 2022.

Oxfam International estimates the top 10 per cent of India’s population holds 77 per cent of national wealth and government data show about 6 per cent pay income tax.

Leaders around the world are trying to narrow income gaps, from China President Xi Jinping’s “common prosperity” program to US President Joe Biden’s proposal of higher taxes for the wealthiest.

Modi, who came to power with the strongest mandate in three decades on a platform pledging dignity for the poor, has often been accused of policies that favour the rich.

Modi, who came to power with the strongest mandate in three decades on a platform pledging dignity for the poor, has often been accused of policies that favour the rich. | Photo Credit: AJAY VERMA

Modi, who came to power with the strongest mandate in three decades on a platform pledging dignity for the poor, has often been accused of policies that favour the rich.

During his first term in office, Modi transformed India into a single unified market by replacing multiple indirect taxes with a goods and services tax (GST) in 2017. A new direct taxes law would complete his tax overhaul; boosting living standards across the population is key for him to market India as a consumer destination that global businesses should target.

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An overhaul of the six-decade-old income tax law was first proposed under Modi’s predecessor in 2009 but successive governments have failed to complete it. While India has tweaked some tax rates and exemptions for individuals and companies, it is still trying to address some other issues such as standardising the tax rates on capital gains.

The government tried to address this issue partially in the recent budget by taxing debt funds at the income tax rate

With a new direct taxes code, the government is also looking to replace India’s complicated tax system with a simpler law to draw in companies looking to shift their operations out of China amid growing tensions between Washington and Beijing.

More importantly, it could help burnish India’s credentials as an investment destination after companies such as Vodafone Group Plc and Cairn Energy Plc challenged tax decisions in courts in the past. 

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