1.1 Chapter X of the Discussion Paper on the Direct Taxes Code (DTC) provides thatincome from transactions in all investment assets will be computed under the head "Capital gains". The DTC provides that gains (losses) arising from the transfer of investment assets will be treated as capital gains (losses). These gains (losses) will be included in the total income of the financial year in which the investment asset is transferred. The capital gains will be subjected to tax at the rate of 30% in the case of non-residents and in the case of residents at the applicable marginal rate.

1.2 Under the Code, the current distinction between short-term investment asset and long-term investment asset on the basis of the length of holding of the asset will be eliminated.

1.3 In general, the capital gains will be equal to the full consideration from the transfer of the investment asset minus the cost of acquisition of the asset, cost of improvement thereof and transfer-related incidental expenses. However, in the case of a capital asset which is transferred anytime after one year from the end of the financial year in which it is acquired, the cost of acquisition and cost of improvement will be indexed to reduce the inflationary gains.

1.4 The capital gains from all investment assets will be aggregated to arrive at the total amount of current income from capital gains. This will, then, be aggregated with unabsorbed capital loss at the end of the immediate preceding financial year (unabsorbed preceding year capital loss) to arrive at the total amount of income under the head „Capital gains‟. If the result of the aggregation is a loss, the total amount of capital gains will be treated as 'nil' and the loss will be treated as unabsorbed current capital loss at the end of the financial year.

1.5 The DTC proposes to abolish Securities Transaction Tax. Therefore, all capital gains (loss) arising from the transfer of equity shares in a company or units of an equity oriented fund will form part of the computation process described above.

1.6 The cost of acquisition is generally with reference to the value of the asset on the base date or, if the asset is acquired after such date, the cost at which the asset is acquired. The base date will now be shifted from 1.4.1981 to 1.4.2000. As a result, all unrealized capital gains due to appreciation during the period from 1.4.1981 to 31.3.2000 will not be liable to tax as the assessee will have an option to take the cost of acquisition for these assets at the price prevailing as on 1.4.2000.

1.7 The DTC also proposes that a new Capital Gains Savings Scheme will be framed by the Central Government. Capital Gains deposited under this scheme will not be subject to tax till the withdrawal from such scheme.

2. The following major issues and concerns have been raised regarding the taxation of capital gains:

(i) Currently, short-term capital gains arising on transfer of listed equity shares or units of equity oriented funds are being taxed at 15% and long term capital gain arising on transfer of such assets is exempt from tax. The withdrawal of this regime will raise the tax liability and may cause fluctuations in the capital market.
(ii) The rate of 30 % for taxation of capital gains in the hands of non-residents is very high as in the case of listed equity shares they are currently being taxed at nil rate if held for more than one year.
(iii) Foreign Institutional Investors (FIIs) play a significant role in the Indian capital market. Various countries, including emerging markets, offer non-residents a special tax regime to attract investments and promote depth of capital markets.
(iv) FII should not be liable to TDS on capital gains as this may cause undue hardship to them. The current provisions relating to payment of the liability as advance tax should be continued.

3. After considering the inputs received the following regime is proposed.

3.1 Income under the head „Capital Gains‟ will be considered as income from ordinary sources in case of all taxpayers including non-residents. It will be taxed at the rate applicable to that taxpayer.

3.2 Capital Asset held for a period of more than one year from the end of financial year in which asset is acquired.

(A) Listed equity shares or units of an equity oriented fund:
Capital gains arising from transfer of an investment asset, being equity shares of a company listed on a recognized stock exchange or units of an equity oriented fund, which are held for more than one year, shall be computed after allowing a deduction at a specified percentage of capital gains without any indexation. This adjusted capital gain will be included in the total income of the taxpayer and will be taxed at the applicable rate. The loss arising on transfer of such asset held for more than one year will be scaled down in a similar manner.

Therefore if the "capital gains" before the deduction at the specified rate comes to Rs.100, it would stand reduced to Rs.50 (if the specified deduction rate is 50 percent). This capital gains would then be included in the taxpayer‟s total income and taxed at the applicable rate. In this example, for a taxpayer in the tax bracket of 10%, such gain will bear an effective tax at the rate of 5% and for taxpayers in tax bracket of 20% or 30%, the effective tax rate would be 10% or 15% respectively.

The Table below gives examples of the effective rate of taxation for different taxpayers at different specified rates of deduction:

Examples of specified percentage deduction for computing adjusted Capital Gain	Effective tax rate for taxpayer whose applicable marginal tax rate is 10 percent	Effective tax rate for taxpayer whose applicable marginal tax rate is 20 percent	Effective tax rate for taxpayer whose applicable marginal tax rate is 30 percent
50	5%	10%	15%
60	4%	8%	12%
70	3%	6%	9%

The proposed scheme is therefore specially beneficial to low and middle income category of taxpayers as they are to be taxed at their applicable marginal rate of 10 percent or 20 percent after the specified deduction for computing adjusted capital gains. The specific rate of deduction for computing adjusted capital gain will be finalized in the context of overall tax rates.

As there will be a shift from nil rate of tax on listed equity shares and units equity oriented funds held for more than one year, an appropriate transition regime will be provided, if required.

(B)Capital gains on other assets held for more than one year

For taxation of capital gains arising from transfer of investment assets held for more than one year (other than listed equity shares or units of equity oriented funds), the base date for determining the cost of acquisition will now be shifted from 1.4.1981 to 1.4.2000. As a result, all unrealized capital gains on such assets between 1.4.1981 and 31.3.2000 will not be liable to tax. The capital gains will be computed after allowing indexation on this raised base. The capital gains on such assets will be included in the total income of the taxpayer and will be taxed at the applicable rate.

3.3 The complexity of maintaining a permitted savings account and retirement benefits account scheme has been discussed in detail in context of EET method of taxation and taxation of Income from Employment. For the same reasons it is proposed not to introduce the Capital Gains Savings Scheme.

3.4 Capital gains on assets held for less than one year from the end of Financial Year in which asset is acquired.

The capital gain arising from transfer of any investment asset held for less than one year from the end of the financial year in which it is acquired will be computed without any specified deduction or indexation. It will be included in the total income and will be charged to tax at the rate applicable to taxpayer.

3.5 Characterization of income of Foreign Institutional Investors (FII)s

A major area of dispute is whether the income from transactions in the capital market should be characterized as business income or as capital gains. This has ramification for taxation in the case of FIIs. A foreign company is not allowed to invest in securities in India except under a special regime provided for Foreign Institutional Investors (FII)s. This regime is regulated by the Securities Exchange Board of India (SEBI) under the SEBI Regulations for FIIs. The regulations provide that an FII can make investment in specified securities in India. The majority of FIIs are reporting their income from such investments as capital gains. However, some of them are characterizing such income as "business income" and consequently claiming total exemption from taxation in the absence of a Permanent Establishment in India. This leads to avoidable litigation. It is therefore, proposed that the income arising on purchase and sale of securities by an FII shall be deemed to be income chargeable under the head „capital gains‟. This would simplify the system of taxation, bring certainty, eliminate litigation and is easy to administer.

3.6 The capital gains arising to FIIs shall not be subjected to TDS and they will be required to pay tax by way of advance tax on such gains as is the existing practice.

3.7 Securities Transaction Tax
The Securities Transaction Tax (STT) is a tax on specified transactions and not on income. Accordingly, STT is proposed to be calibrated based on the revised taxation regime for capital gains and flow of funds to the capital market.