How the world taxes capital gains on equity

But, over the years, there have been growing concerns, not just in India but also many other countries, that levying tax on capital gains might become a strong disincentive for people to make investments, and this in turn could further hinder economic growth.

Graphic: Mint

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Graphic: Mint

It is in this context that capital gains generally receive preferential tax treatment in many countries compared to any other income. For example, in India, long-term capital gains on various assets are generally taxed at 10-20%, while the highest income tax rate applicable on regular income is 30%. Similarly, in the US, capital gains are taxed at 0-20%, while the top tax rate for ordinary income is 37% for individual taxpayers.

A working paper by the International Monetary Fund (IMF) published in January reveals that special rates are the predominant form of taxing capital gains across countries. “Indeed, 57%, 41% and 60% of countries in advanced economies, emerging markets and low-income developing countries, respectively, use a special rate to tax capital gains..” as per the paper titled ‘progress of personal income tax in emerging and developing countries’.

Further, many countries exempt taxes on capital gains up to a certain limit, which is otherwise not available for ordinary income. For instance, in the case of long-term capital gains (LTCG) on listed shares, India exempts 1 lakh per annum of capital gains earned. Similarly, in the US, LTCG on shares up to $44,625 are taxed at nil rate. The exemption limit, in both countries, is about 0.6 times its per-capita income in 2021. To give a perspective, in 1950, the exemption limit as a multiple of per-capita income was 57 times in India. This shows how the exemption limit has plummeted significantly (compared to income levels) over the years.

“When you deep dive and look at the laws in different countries, the CGT regime actually turns out to be pretty complex. There are different rules for different asset classes on computation of capital gains, holding period, loss offset provisions, tax rates, surcharge etc. I think India is no exception to this system.” said Rajesh Gandhi, partner at Deloitte.

Having said that, the cross-country comparison of LTCG taxation and dividend from listed equity reveals that the tax structure in India is simpler compared to most countries, if not most beneficial to the taxpayer.

In this story, we look at the LTCG tax regime for equities in various countries—India, US, Canada, UK, Australia, China, Japan, the UAE and Singapore—and how India is ranked on this basis. The analysis is based on data obtained from each country’s official tax websites, PwC’s (PricewaterhouseCoopers) information on ‘Worldwide Tax Summaries’, and inputs from Deloitte.

Preferential treatment

Among the countries listed above, capital gains are completely exempt from tax in Singapore and the UAE. Let alone capital gains, the UAE does not levy any income tax on individuals, making it one of the few countries to treat income free of tax, the kind of tax system one could only wish for everywhere.

India taxes LTCG on listed equity at a flat rate of 10% for amount exceeding 1 lakh per annum. Japan and China also tax capital gains at a flat rate of 20.315% and 20%, respectively, but without any exemption and differentiation between LTCG and short-term capital gains (STCG).

No exemption, whatsoever, on capital gains, makes individuals in these two countries pay a higher tax amount on capital gains compared to their counterparts in other countries (see table).

The higher-income countries—US and UK—do not have a flat rate tax system but follow a separate slab structure (smaller) compared to regular income. In the US, capital gains of up to $44,625 are exempt from tax, while the UK allows a deduction of £12,300 per annum from capital gains.

While the exemption/deduction amounts differ drastically between India, US and UK, the limit is about 0.4 – 0.6 times the per capita income in the respective countries, creating a level playing field for taxpayers when it comes to taxing capital gains on shares.

Taxed as regular income

Canada and Australia—two other higher income countries—treat capital gains as any other ordinary income and levy tax at the individual slab rates.

Having said that, both the countries allow 50% deduction from the capital gains amount.

While this may seem to be a major advantage for taxpayers here, the higher income tax rates in these countries, especially Australia, keep the tax rates on capital gains elevated, compared to India and most other countries.

Dividend taxation

Even in the case of dividends, India follows a simpler taxation method. Dividends are taxed entirely in the hands of shareholders at the individual’s applicable slab rate. Of course, this is not comparable to the UAE and Singapore, where dividend income is also exempt for individuals.

Canada and Australia require individuals to gross up the dividend income received. In simpler terms, it means to increase the dividend income received to their value before taxes, which would have been paid by the company distributing the dividend. The grossed-up dividend has to be added to an individual’s ordinary income from which a certain amount of ‘dividend credit’ can be deducted. The net income is taxed at individual’s respective slab rates.

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