Over Rs 12 lakh crore was wiped out from stock markets within a month of introduction.

By Siddarth Pai & TV Mohandas Pai

Will Durant, the eminent historian, visited India in 1930, for research for his eleven-volume tome, The Story of Civilization. The sheer depredations he witnessed during his visit, inflicted upon India by British policies, moved him to pen down A Case for India, a seminal work cataloguing the impact of Britain’s policies in India in the hobbling of a once-great civilisation. In the section titled “Economic Destruction”, he begins by remarking, “The economic condition of India is the inevitable corollary of its political exploitation”. He then goes on to detail the scale of the rapacity through first-hand accounts, citations, memos and calculations by the British Crown themselves. He sums up India’s dismal condition by stating, “To this ruining of the land with taxation, this ruining of industry with tariffs, and this ruining of commerce with foreign control, add the drainage of millions upon millions of dollars from India year after year and the attempt to explain India’s poverty as the result of her superstitions becomes a dastardly deception practised upon a world too busy to be well informed”.

For the first 44 years of India’s Independence, until its economic liberalisation in 1991, this summation by Will Durant was an apt description of the impact of the economic policies of the ancient regime and administrations of India, especially with regard to taxation.

India has had a long history of taxation, with works such as the Manusmriti, Kautilya’s Arthashastra and Raghuvamsa by Kalidasa deliberating upon just means of taxation. Many Indian finance ministers quote from these works—about how tax collection must be like the sun collecting vapour from droplets of water, or how a bee extracts honey from flowers. But, in reality, our present system of taxation is divorced from our accumulated civilisational knowledge, and instead, it bases its practices upon the system created by the British. Our modern Income-Tax Act traces its roots to 1860 when the system was put in place by Sir James Wilson to help the British Crown recoup its expenses from India’s First War of Independence in 1857. It must be noted that when a similar tax was placed by the British on their American colonies following the Seven Year War, the colonies rebelled and declared independence. From the original act of 1860 came the 1922 Act, which gave birth to the current Income Tax Act, 1961.

But old practices die hard.

India’s Income Tax Act still carries vestiges of its colonial hangover. The I-T Act still contains provisions that inherently suppress domestic capital. A lot has been said about angel tax (Section 56(2)(viib) or as the authors have deemed it, the Indian Tax)—a tax on investments by Indians into the securities of private companies if the investment is above the “fair market value” of the securities—a value usually determined by the tax officers themselves and litigated thereafter. Along with this, sections such as Section 68 are meant to attack unexplained cash credits, but are used as a stand-in for angel tax. Both these sections exempt foreign investments and are solely targeted and misapplied towards Indian citizens who dare to invest into startups of their own country.

Even on an institutional level, we see examples of such discrimination against Indians investing in India. The definition of the term “capital asset” (Section 2(14)), a term used as the yardstick to determine whether income falls under capital gains or any of the other heads, specifically states that securities held by FIIs will always be considered as capital assets, and subject to more beneficial treatment and rates compared to Indian investors. Indian hedge funds and other investors have long argued for the same treatment but to no avail. Instead, reliance is placed on circulars which have a lacuna regarding short-term holding, leading to further litigation and ambiguity. The latest attack on domestic capital comes in the form of the “super-rich surcharge” introduced on July 5, 2019 by the current, honourable finance minister. This was a surcharge of 25% or 37% on incomes above Rs 2 crore or Rs 5 crore respectively. Over Rs 12 lakh crore was wiped out from stock markets within a month of introduction. As FPIs pulled out capital, officials made fatuous statements such as “It is a little collateral kind of consequence” or …”our share markets actually being in very high PE ratios, it is not in the economic disinterest of the country if, slight exit takes place”. The most damning of which was asking pension trusts, usually created under acts of the parliaments of their respective countries, to restructure as corporates to avoid the fall-out of this surcharge. Only when the economic consequences of the “collateral kind of consequence” became too much to bear did the government roll back the super-rich surcharge on listed securities and foreign investors wholesale. By virtue of the rollback of the “super-rich surcharge” on foreign investors, and cataloguing all securities held by FII as “capital assets”, the income from derivatives and dividends is taxed at a lower, more beneficial rate for foreign investors, whereas the same class of income is taxed at the maximum marginal rate for Indian investors.

Likewise, Section 9A was meant to be a way to “onshore the offshore”—to ensure that the Permanent Establishment rules don’t apply to a fund based offshore just because the fund manager is based in India. This section has so many conditions about the fund size, location, number of investors, etc, that even after multiple iterations and changes, only three funds have applied for the same. As per our tax policies, the entry to Indian equities isn’t via Mumbai—it is via Mauritius. These are just some examples of the colonial hangover of the thought processes behind India’s income tax regime, but the I-T Act is unfortunately riddled with many more examples.

The reason for this discrimination can be encapsulated by paraphrasing Mark Antony’s speech from Shakespeare’s Julius Caesar, where Antony says, “Not that I loved Caesar less, but that I loved Rome more.” Similarly, many have argued that our tax policies don’t love Indian investors less, but foreign investors more. A core reason for this preferential tax treatment can be traced back to India’s economic liberalisation in 1991 when our foreign reserves were at an all-time low and India had to pledge over 60 tonnes of gold to get a bailout from the IMF, amongst others. The situation at that time necessitated policies to bolster our foreign reserve and help develop our capital markets.

But now, with a stock market capitalisation of $2.1 trillion and forex reserves of $475 billion before the Covid-19 crash, India needs to develop policies that promote domestic capital rather than suppress it. History is rife with such parallels in India’s economic journey—USA grew through European investments before it began to look to their own people and incentivise them to invest domestically; China welcomed foreign capital when their markets opened up, but domestic capital accounts for over 60% of funding for their own startups; Japan too grew using foreign capital, but began to cultivate deep pools of domestic capital. India is seeing this play out in its stock market as well. In spite of the lack of parity between DIIs (Domestic Institutional Investors) and FIIs (Foreign Institutional Investors) thanks to India’s tax policies, in times of crisis, DIIs have been net buyers as compared to FIIs

In the unlisted market, foreign investment of Indian firms grew 18% to $2.69 billion in March 2019 compared to the previous year. To compare, Indian investors constituted less than 10% of the $14 billion that Indian startups received in 2019. India is at risk of becoming a digital colony because of the discrimination meted out to investors in its own startups! The LRS spend of Indian residents followed a similar trend.

India does not lack capital—it lacks the institutional attitude to cultivate and incentivise domestic capital investments. PM-CARES, launched to galvanise donations to fight Covid-19, got over Rs 6,500 crore in one week—three times what the PMNRF got in two years. This shows that Indians are willing to donate and invest for the right cause, if they are treated with respect and not discriminated against.

Now, in the midst of Covid-19, the world order is being reset. At this crucial juncture, the aspersions cast upon Indians at the hands of officials and tax policies is a disservice to India’s citizens. India can no longer afford to suppress domestic capital and must shed the colonial mindset that dictates its economic and tax policies. The new BC and AD will become “Before Covid-19” and “After Disease”, and India, under the leadership of prime minister Narendra Modi, must shed these vestiges of the colonial hangover. India achieved independence in 1947 and saw economic liberalisation in 1991; but sadly, going by Will Durant’s chronicles, even today, Indian tax officials treat Indian citizens just like their British counterparts did in 1930.

Siddarth is managing partner, 3one4 Captial & Mohandas is chairman, Aarin Capital. Views are personal