Tax freebie or tax reform? It varies depending on who you ask.

When the favourable tax treatment of debt MFs was done away with, there was a hue and cry from those who benefitted from it.
When the favourable tax treatment of debt MFs was done away with, there was a hue and cry from those who benefitted from it.


  • If a 'reform' pushes up corporate profits or encourages more investors to invest money, that’s taken as pro-economy, irrespective of whether it leads to lower tax collections. But if the government spends on helping the poor, that’s called fiscal profligacy. India needs a fair taxation system.

With the central government’s budget due to be presented in July, the phrase ‘economic reforms’ is in the air, especially among those in the business of managing other people’s money (OPM) and those in the business of managing the so-called system for corporates.

But the phrase ‘economic reforms,’ like many such terms, doesn’t really have a clearly defined meaning. Indeed, it might be safe to say that what might seem like a ‘reform’ to one person might seem like a revdi or handout to another. Allow me to explain.

My first job in journalism required me to write on personal finance. I realized very quickly that a decent understanding of India’s complex and convoluted Income Tax Act, 1961, could be a regular source of stories. And within months of this realization, there was another—that India’s income tax system was built for the rich, particularly the non-salaried rich.

Let me share two examples. For many years, mutual funds (MFs) would launch fixed maturity plans (FMPs) just before a financial year (FY) came to an end. FMPs were debt MFs which came closest to operating like fixed deposits (FDs). They had a fixed maturity period. When that period ended, the initial investment along with the returns earned would be handed back to the investor, like with an FD.

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Now, these FMPs would be launched towards the end of one FY and would mature in a little over a year’s time. Let’s say the last date for investing in an FMP was 29 March 2007. This scheme would then mature on 2 April 2008. On the face of it, the maturity period was just a little over a year; nonetheless, it needs to be pointed out that such an FMP launched in FY 2006-07 remained in existence through 2007-08 and matured just at the start of 2008-09.

And this is where a legal tax dodge came in. The moment an investment in a debt MF was held for more than a year, indexation, or accounting for inflation while calculating capital gains, came into the picture. Here, the investment started in one FY, was held during the next FY and matured in the third, so double indexation came into play.

Let’s say an investor invested 1 lakh and earned a return of 10%, resulting in a maturity amount of 1.1 lakh. If inflation averaged 5% per year, then the cost price for the investor could be claimed at more than 1.1 lakh. Hence, for tax purposes, the investor would actually make a capital loss, implying that no tax had to be paid on real capital gains. 

The irony of this device was that even though the maturity period was just over one year, for tax purposes, inflation for two years could be taken into account. The MFs raised thousands of crores every year through this dodge.

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Let’s take one more example. For many years, interest of up to 1.5 lakh a year paid on a home loan on a self-occupied home could be deducted while calculating taxable income. But the moment one took on a second, third or nth home loan, the entire interest paid on that home loan could be deducted while calculating taxable income, as long as a notional rent was taken into account. This became a great tax dodge for the rich because the annual rental yield in the country was around 2%, whereas interest rates were 9-10%.

Thankfully, both these tax dodges are no longer possible, but while they were on, one did not hear of a single OPM wallah talk about them, or of corporate lobbies complaining about how one of these dodges encouraged real estate speculation, making things doubly difficult for those who wanted to buy homes to live in.

Indeed, when the favourable tax treatment of debt MFs was done away with, there was a hue and cry from those who benefitted from it. A similar outcry arose after long-term capital gains on equity and equity MFs became taxable.

In all these years of writing on personal finance and economics, I have neither seen OPM wallahs nor corporate representatives talk about the loss of tax collections for the government due to the availability of such dodges. But they all lined up to welcome India’s cut in the corporate income tax rate in September 2019, as if that did not lead to lower tax revenues.

When the Mahatma Gandhi National Rural Employment Guarantee Scheme and the Food Security Act, especially the latter, became the order of the day, many comments were made, including by yours truly, on the dangers of fiscal profligacy. Clearly, whether it’s a revdi or a reform depends on who you ask. 

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If a so-called reform helps push corporate profits or encourages more investors to invest money with OPM wallahs, that’s taken by these interest groups as reform, irrespective of whether it leads to lower taxes. But if the government decides to spend some more money on helping the poor, that’s called fiscal profligacy, as if the sole aim of the government should be to drive up stock market indices.

To conclude, the coming budget is a good time for the finance ministry to do away with some pointless distinctions that still exist in the taxation of different kinds of income. There is no reason why income from the buying and selling of stocks and real estate should be taxed in a different way than salaried income or income from FDs or what is earned by the self-employed.

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