Proposed levy on financial assets could hit capital formation

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Finance minister P. Chidambaram’s proposal to levy wealth tax on financial assets of individuals and trusts above Rs50 crore is set to hit not just affluent investors but entrepreneurs too, say tax experts.

If one takes the example of Reliance Industries chairman Mukesh Ambani, the proposal could lead to an extra tax demand of Rs 86 crore a year on the 36 lakh shares he holds in the company. Internet entrepreneurs, whose companies may have fairly good market capitalisation but little revenue flow, may also find it hard to comply with the proposed wealth tax norm.

While official sources said the tax base of wealth tax has not been precisely quantified, rough estimates suggest the proposed 0.25% tax, if signed into law, could fetch a maximum of Rs 19,000 crore assuming the entire market capitalisation of financial assets accounting for 60% of the Rs 1,28,39952 crore GDP projected for 2014-15 is taxed. However, only those owning assets worth more than Rs 50 crore would come under the tax net, lowering estimates of receipts from this tax further.

Experts, therefore, worry whether changes in wealth tax would be worth the effort and warned that the move may lead to undesirable results. “Including financial assets within the scope of wealth tax will cause a lot of hardship to entrepreneurs who may not have the cash flow in the initial years to comply. This would adversely affect capital formation,” said Girish Vanvari, co-head, tax, KPMG in India.

The revised Direct Taxes Code released for public comments earlier this week raised the threshold for this levy from Rs 30 lakh to Rs 50 crore, lowered the rate to 0.25% from 1% now and excluded companies from the scope of this tax. The revised code proposes to tax financial assets in the hands of individuals, Hindu undivided families and private discretionary trusts. At present, companies are covered under wealth tax but they will not be under wealth tax ambit if the code is implemented.

“One has to leave aside the emotions of taxing the super-rich and dispassionately analyse the cost of wealth tax collection against the amount that could be garnered. I doubt whether such collections would help in reducing the fiscal deficit. This (proposed change) amounts to paying taxes on market value of assets when there is no cash flow. Does one expect taxpayers to sell the financial assets and pay wealth tax?” asked Sudhir Kapadia, partner & leader, business tax services, EY.

Levying wealth tax on the market value of a financial asset would mean paying tax on sentiment-driven valuations without actually benefiting from such valuation, which is possible only at the time of a sale.

But the finance ministry is of the view that the cost of acquisition of an asset may not be the right indicator of the value of an asset and, therefore, cannot be the basis for wealth tax.

The ministry was earlier of the view that wealth tax was just a means to collect information on assets, but subsequently changed the view that it is only one of the objectives. The tax department has been increasingly paying extra attention on assets of assessees to see if they correspond with their declared income as black money became a sensitive issue in the last few years.

“This concentrated effort to target the very rich was not part of the original DTC and it is a retrograde step,” said Neeru Ahuja, partner, Deloitte Haskins & Sells.