Mumbai: Reserve Bank of India governor Urjit Patel said that India’s taxation structure, with multiple taxes on capital, will impact savings and investment decisions, adding heft to the market chorus protesting the long-term capital gains tax.

“The taxation on capital in India is from several sources and I think that at the marginal rate it adds up," said Patel while answering a question on India’s investment rate during a post-monetary policy press conference.

“...you have the corporate tax rate, you have the dividend distribution tax rate. For dividend income above Rs10 lakh, you have the marginal tax rate, which is whatever bracket people come in, that would be at the highest level. You (also) have a securities transaction tax and you have a capital gains tax. There are five taxes on capital and that would obviously also have an impact on investments and savings decisions," said Patel.

Economic Survey data showed that the investment-to-gross domestic product ratio peaked at 35.6% in 2007 but fell subsequently. It was 26.4% in 2017. Similarly, domestic savings peaked at 38.3% of GDP in 2007 before falling to 29% in 2016.

The Union budget on 1 February re-introduced long-term capital gains tax on equities and equity-linked instruments. LTCG tax on sale of equities will be applicable on gains exceeding Rs1 lakh. The tax rate is 10%. The tax roiled equity markets on budget day. The Sensex closed at 35,906.66, down 0.16%, its worst budget-day performance in the five years of this government. While Indian equities’ subsequent losses are more to do with a global stock rout, experts remain divided about the re-introduced tax.

“The government’s proposal could have the effect of encouraging long-term holding of shares. That could curb excessive speculation and it won’t be a bad outcome," said R. Narayanaswamy, professor of finance and control at the Indian Institute of Management, Bangalore. “That said, it is true that because of the multiple taxes on dividend and capital gains, the effective tax rate on financial income goes up. After the real estate meltdown over the last three or four years, equities are the only inflation-indexed investments available to the middle classes," he added.

While the finance ministry did not immediately react to the RBI governor’s statement, finance secretary Hasmukh Adhia had earlier said at the CNBC-TV18 Mint Budget Verdict event that one asset class should not be left untaxed.

“We have protected the interests of the retail investors by giving an exemption for gains up to Rs1 lakh. The whole idea of levying LTCG is that we should not leave one class of assets absolutely without any taxation. When that happens, that particular class of assets becomes very attractive. Even when valuations are not correct, people rush to invest. And this is a potential risk for the economy," said Adhia.

These explanations haven’t cut much ice with market participants.

“Market participants have voiced concerns that the tax structure is making India less attractive. The Securities and Exchange Board of India (Sebi) is worried that this could lead to export of capital to other investment destinations such as the Singapore Stock Exchange (SGX). There is strong discussion to ask the government to reconsider the decision or at least remove STT," said a person aware of the matter. “Sebi’s initial recommendation was only a levy on penny stocks to stop the misuse of LTCG," he added.

An email sent to Sebi on Wednesday was not answered till press time. LTCG is one of the topics for discussion when RBI and Sebi boards meet the finance ministry on 10 February for a post-budget consultation, this person said.

“LTCG exemption was an attraction for new investors in equity/equity mutual funds and brought funds from other low-paying avenues. Rising interest rates domestically and tax on LTCG could result in a minor reversal of this trend," said Dhiraj Relli, MD and CEO at HDFC Securities.

Nasrin Sultana contributed to this story.

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