Capital gains taxation will be near ideal under DTC

Mohan R. Lavi | Updated on July 14, 2011

With rationalisation of Capital Gains taxation, it is widely felt that India has moved into a comfort zone with near-ideal tax rates and hence there is no need to rock the boat too much.

Taxes occupy an important position in the sources of revenue for any Government.The impact that these measures have on the economy are felt years later. During his Presidency, George Bush administered a liberal dose of tax cuts the impact of which is being felt even today.

The United States of America is still debating the impact that the “Bush Tax Cuts” have had and their relevance in turbulent times. The Bush tax cuts had end-2010 as their sunset year and were given a two-year extension by the Obama administration after much debate. The same administration now feels that certain provisions of the tax laws need to be altered to ensure that hedge fund managers pay what they ought to.

Taxing Hedge Funds

Hedge fund managers generally make their money by charging their clients two fees.  First, the manager receives a management fee, typically equal to two per cent of the assets invested.  Second, the manager typically receives 20 per cent of the income from those investments above a certain level. This 20 per cent share of the investment returns from hedge funds is known as carried interest.  Under current law, most hedge fund managers claim that this carried interest qualifies as a long-term capital gain, currently subject to a maximum tax rate of 15 per cent, rather than being taxed as ordinary income, subject to a maximum rate of 35 per cent.

Transfer under DTC

Such a generous tax relief and imaginative interpretation would not work in India where tax laws have always insisted on a transfer to take place for capital gains to be triggered. The concept of transfer would also encompass shadow transfers by way of complex agreements as Vodafone is discovering in a costly fashion. Clause 314(267) of the Direct Taxes Code( DTC) elaborates 16 different methods in which a transfer can be deemed to take place. Clause 46 of the DTC specifies that the income from transfer of any investment asset shall be computed under the head Capital Gains. Subsequent sections list out 6 inclusions and 23 exclusions from the definition of transfer in each of which the word transfer is found. Investment Asset has been defined to mean any capital asset which is not a business asset, any security held by a foreign institutional investor (FII) or any undertaking or division of a business. Inclusion of securities held by FIIs in the definition of investment asset precludes them from opting to show this as their business income.

With rationalisation of Capital Gains taxation, it is widely felt that India has moved into a comfort zone with near-ideal tax rates and hence there is no need to rock the boat too much. Taxation of SEZ units and ensuring a seamless transition to Goods and Service Tax (GST) appear to be the only riddles that the Government has to solve as far as local taxation goes. While the former would get resolved eventually, fractured relationships with State Governments could shelve the latter for the present. The recent pact with Singapore to share information as per OECD norms is a pre-cursor of activities anticipated in international taxation. The DTC with its mix of blow-hot blow-cold measures could have an initial impact, but should stabilise revenues over a period of time.

(The author is a Bangalore-based chartered accountant.)

Published on July 09, 2011

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