Removal of indexation benefit: You may still owe tax even if your 'return' is negative
Dhirendra Kumar
CEO, Value Research
Last year, as I wrote on budget day evening, I worried there wasn't much to say. After thinking about it, I realised that having little to say is kind of good. My focus is investment and taxation, so nothing to say means no changes, which is mostly fine.
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This year, there's much to say. The biggest shock is the elimination of cost indexation for capital gains tax. Former finance minister Arun Jaitley restored long-term capital gains tax on equities investments without indexation a few years ago. I wrote that the minister had rendered "this tax deeply unfair by not allowing inflation indexation." India allows inflation indexation for all long-term capital gains, including bonds, real estate, and unlisted equities. It is a cornerstone of fair taxation that the government cannot tax inflation-affected values. Why does this tax ignore this principle? Nothing justifies it."
I had little idea that indexation will be eliminated for all capital gains taxes, including real estate, within a few years. This large change is hard to justify on principle. This might mean that tax consumes all real returns for many assets. Consider equities returns, which rarely exceed 3-4% above inflation. The 10% tax on full returns might take 20-30% of your inflation-adjusted gains. Each transaction may cost you a fifth to nearly a third of your profits to taxes. Indeed, this estimate may be conservative. Even if your inflation-adjusted returns are negative, you may owe this tax. Imagine an 8% investment return with a 10% inflation rate. This reduces your purchasing power. When investments allowed indexation, you wouldn't owe any tax in such a situation. Under this new regime, you'd be taxed even though your worth has decreased.
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Another issue I have is the gradual shift towards the new income tax system. I expect the new regime to become mandatory in the near future, especially with the FM promising a complete redo of the Income Tax Act. The new system seems simpler with no exemptions and lower tax. However, the lack of tax-saving options is a concern. I believe it will result in reduced savings and more financial problems for many people later in life.
Without investment tax incentives, many people-especially younger, lower-income ones-may not save. Our consumer-driven society promotes spending over saving. Only the savings tax rebate counterbalances this trend. Its effects go beyond tax-saving investments. These savings frequently inspire wider savings. This is common among young people I know. They start with tax-saving investments and get significant returns due to lock-ins. This initial experience inspires lifelong savings and financial security for many.
Also read: Income tax changes in Budget 2024: New tax slabs, standard deduction limit hike, other key announcements in new tax regime
I hope the new tax regime would still encourage saving despite its simplicity.
(The author is founder, Value Research.)
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(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
This story originally appeared on: India Times - Author:Faqs of Insurances
