Budget measures will leave small investors cold

The Union Budget 2012 has tried to attract small investors into the stock market leaving mutual funds in a mess. It shows knee jerk reaction, no understanding of ground reality and policy confusion

Finance Minister Pranab Mukherjee, in his budget presentation speech for the fiscal 2012-13, announced a slew of measures to encourage the small investor to participate in equity markets. Would these be effective or was the FM poorly advised about what his measures really mean? The budget proposals include:

  •  Rajiv Gandhi Equity Scheme to deepen investor base and reduce volatility, allows for 50% deduction to the small investor, to an annual limit of Rs50,000 in equities. However, this will apply to only those investors up to Rs10 lakh income to be eligible for the scheme. Investment will also have to be locked-in for three years.
  •   The Securities Transaction Tax (STT) on cash delivery transactions has been reduced by 20%, from 0.125% to 0.1%, in order to reduce transaction costs in the capital markets.
  •   Additionally, the FM has modified IPO guidelines to broaden investor reach. To achieve this, it is mandatory for companies to issue IPOs of Rs10 crore and above in electronic form through nationwide broker network of stock exchanges.
  •   The finance minister has also proposed a central Know Your Customer (KYC) depository will be developed in 2012-13 to avoid multiplicity of registration and data upkeep.

The overwhelming emphasis on the equity markets is a policy volte face, most likely a result of no organised thinking but a knee jerk reaction to the declining interest of savers in the equity markets. For the last 20 years, there has been a continuous emphasis on mutual funds as an effective tool for small investor participation and investment. Investors have been told not to trade in equities if they are not sure what they are doing. However, now the FM is offering incentives to small investors to buy equities while mutual funds have been effectively killed when the market regulator started messing around with commissions (starting with banning entry load and upfront commission in August 2009) under chairman CB Bhave, which the current chairman has perpetuated. Following this, many distributors have stopped selling mutual funds thus restricting their reach to small investors. And now, instead of fixing this problem, the government is instead pushing these investors from mutual funds back to equities without any debate.

The tax incentive for equity investment is also a not a well-thought out idea. We have been had 100% exemption long-term capital gains in equity investment (over one year) for years now and yet there has been little equity participation despite this huge benefit. What is the point of having a three-year lock-in period when long-term capital gains, which is totally exempt for capital gains over just a year is not being availed of? Merely locking in investors with the Rajiv Gandhi Scheme, for Rs50,000 tax benefit, is convoluted and has no logic. They might as well bypass the scheme altogether and invest in equities, where capital gains are tax-free. The government seems to have missed the point.

The reduction in STT for delivery trades, while welcome, would also not mean much. The bulk of volumes comes from speculation in futures and options. This minor tweak of reducing STT for delivery trades amounts to no incentive at all for non-investors and is unlikely to entice them to the stock market.

Why has the FM suddenly tried to bring small investors back into the market? After years of thoughtless policies, cumbersome regulations, poor grievance redressal and no course correction, India's investor population is declining.
Moneylife has been repeatedly pointing out that India's investor population has declined from 20 million in the 1990s to just over 8 million by 2009 (as per the D Swarup Committee report). All this while the regulators who live in the ivory tower were unconcerned about this phenomenon. Suddenly, the drought of new issues and the government's failure to disinvest easily has woken up policy makers (mainly the market regulator) to the sad state of stock markets. But since they have no truck with reality, the measures they have suggested to the FM would turn out to be meaningless.



Adi Daruwalla

5 years ago

This is a rich mans budget. Where the relief is actually required for people in the 2 - 5 lakhs income bracket there is no relief. This will be referred to as the jerks helping the jerks reaction, while those who require the help are in the murk.

S R Balasubramanian

5 years ago

You have hit the nail on the head. The Govt seems rudderless and short of ideas. They seem to have done precious little to make investments easier and profitable. It seems bureaucrats are having a field day.

Nagesh Kini FCA

5 years ago

A listless budget that has all token provisions the niggardly Rs.20,000 hike in the basic exemption, then the Parliamentary Committee had proposed Rs.3,00,000. The Preventive Health care deduction of Rs.5,000 doesn't cover basic tests. The TDS on Bank deposits and exempting only SB and not Term Deposits makes no sense. Investment of capital gains in SME in a circutous route and the Rs.000 Rajiv Gandhi Yojana all evidence lack of proper thought on the part of the FM.


5 years ago

Other than long term capital gains from equity being tax free, there is already an existing provision to invest any amount upto Rs.1 lakh in ELSS and claim 100% deduction. This is applicable for both ‘old’ and new’ investors. So how Rajiv Gandhi equity scheme will help better? How small investor is expected to pick stocks? Even genuine sub-brokers, in small cities may not be knowledgeable to help them. So investors may be stuck with dud stocks for 3 years.

ELSS is more advantageous as though for the investor the money is locked-in for 3 years, the fund manager is free to make change in portfolio any time.

Request you to write about impact of TDS on real estate transactions and gold.


5 years ago





N Rajagopalan

5 years ago



5 years ago

UPA Govt., at the Centre is not worried about Indians - The Prime Minister, Dr. MMS is working overtime to sell India to Foreign companies and Sonia (not Gandhi) is only worried about her son being made as the PM of India.

1.2 Billion of Indians can not have an Indian as the ruling party chief, its a clear way to doom India.

Govind Shanbhag

5 years ago

DB & AG Sirs - Looking at the budget, there is not going to be mid term elections. Senior ciizen (SC) , who along with hutment dwellers religiously vote have been left dry. Now due to service tax going up, this will attract inflation and worst sufferers would be sc. The budget fails to woo women - both working and non working and we do not know the concession of 15K which women were enjoying earlier is there or taken away. There is no need to read tomorrows budget specials in news papers as nothing great is there in budget.


ruma mukherji

In Reply to Govind Shanbhag 5 years ago

as service tax is extended to the ac coaches in a train,the the fare in total will get more by 12% and cess.well done fm sahab.


5 years ago

The proposed scheme is only for new investor only and it is once in life time. FM is doing the right thing by not extending STT reduction to F&O segment as F&O can not be considered as investment instrument and it will be better for small investor to keep away from it

Krishnaswami CVR

5 years ago

@srini: The scheme already exists in mutual funds as ELSS which has a lock in period of three years. It is now being extended to direct investments in equity also. While it is laudable and aimed at more retail participation, the tax payer is not compensated for the risk which he undertakes. Hence I am of the opinion that the scheme proposed should be linked to the exemption of capital gains tax.


5 years ago

I think this scheme it will be extended to mutual funds too.


5 years ago

Does this mean that you buy a particular share and cannot exit it for 3 years? How ridiculous? Instead, the FM could have allowed this concession for investing in Equity Linked Mutual Funds. This would have revived the mutual fund markets as well.

Krishnaswami CVR

5 years ago

I agree with the general trend of the article and hope FM will take notice and make amendments particularly in respect of lock in period coinciding with long term capital gains.

As the author himself points out that bulk of the speculation lies in the ambit of F&O, is he not justified in reducing the STT only on investments. It may also be pertinant to point out that such reduction would pave way to meet the demands of FII, at least in part?

Economy & Nation Exclusive
Budget 2012 and the Vodafone ruling: FM travels back in time to undo ruling

The proposed amendment to Section 9 is travel back in time machine, and travel wide to the world at large, and catch all transactions all over the world over last 50 years! Hats off to the imaginative and ambitious person who has drafted the clause!

The Finance Bill 2012-2013 has carried out several major amendments to the Income tax Act, 1961 to negate the effect of the court decisions and make transactions having effect in India taxable. Notably, the amendment (that is, insertion of proposed Section 9) dates back to 1st April 1962-the day the Income Tax Act came into force.

This article seeks to analyse and set out the interpretations and principles laid down by the Indian courts on what this substance would comprise and how the same may be established, vis-a-vis the retrospective amendments that the Finance Bill 2012-2013 brings.

Taxability of offshore entities in India-judicial overview
If an offshore entity having a transaction in relation to Indian assets fails the 'substance' test, it will be taxable in India. The important question is, what constitutes this 'substance' or when can it be said that the offshore entity is outside the domain of applicability of the Indian tax laws. The taxability of an offshore entity in India, inter alia, depends on the following key factors:

(a)    Whether the entity is set up offshore merely to avail treat benefits?

(b)    Whether the situs of a capital asset is in India;

(c)    Whether the effective management of the offshore entity is being carried out of India; and

(d)    Whether the offshore entity can be said to be non-resident of India for tax purposes.

The Indian courts have adjudicated on taxability of offshore entities on grounds of treaty shopping in a few cases, which may be referred to while determining the issue of taxability in India. Few of the importance cases are summarized as hereunder:

1.    McDowell and Company vs Commercial Tax Officer

The five-judge bench laid down that tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It can, therefore, be concluded that as long as tax planning is within the ambits of law, it is legitimate.

2.    Union of India vs Azadi Bachao Andolan

The matter related to validity of investing through Mauritius and the question of 'residency' while determining taxability in India. The division bench of the apex court discussed and held several important aspects:

(a)    For availing the treaty benefits under the India-Mauritius Double Taxation Avoidance Agreement, the Tax Residency Certificate (TRC) issued by the Mauritius Revenue Authority is sufficient proof to residency of the entity in Mauritius. It was further upheld that capital gains from sale of shares held in India by a Mauritius entity would be taxable in Mauritius where such Mauritius entity holds a TRC.
It may be noted that to obtain a TRC, the Mauritius entity needs to establish sufficient substance, viz. At least two directors shall be resident in Mauritius, the entity shall have board meetings and decisions making process taking place in Mauritius, a bank account in Mauritius shall be maintained and all monies shall be channelled through such account, all accounting records shall at all times be maintained at the registered office at Mauritius, etc.

(b)    Analysing the McDowells decision, the division bench said that the decision may be interpreted to mean that a taxpayer shall have the liberty to choose the alternative which is more tax efficient and the act which is otherwise valid in law cannot be non-est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests. The Court, therefore, declared the form over substance supremacy in case of tax planning.

The Vodafone thriller

The Bombay High Court holding the tax liability in India on the Vodafone transaction (sale of shares) between two non-resident entities, sent shivers of worry across the investors. Though the major aspect of the case was whether the corporate veil of the non-Indian entities can be lifted, mostly a question of form vs substance, the apex court also analysed and adjudicated upon the Mauritius route for investments into India. Not only did the Supreme Court hold transfer of shares between two non-Indian entities as not taxable in India (even though the underlying assets were located in India), the Supreme Court has, inter alia, also laid down several important principles that highlight the 'substance requirement' and taxability of offshore entities:

(a)    Validity of tax planning:

(i)    The cardinal principle is that if a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance. The court stated the 'Look At' principle: it is the task of the court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach.

(ii)    A transaction may fail if it is a 'fiscal nullity' which would arise where a transaction is devoid of any commercial substance.

(b)    Lifting of corporate veil:

(i)    A holding company and its subsidiaries are separate legal entities and, therefore, shall be resident of the country of incorporation, except where the business of the holding company is the business of the subsidiary (i.e. the subsidiary is an alter ego of the holding company). However, in a concurring judgement, justice KS Radhakrishnan was of the view that the identity of a subsidiary can be ignored where special circumstances exist indicating that it is a mere facade concealing true facts. Therefore, rejecting the alter ego stance, justice KS Radhakrishnan stated that the court will not permit a corporate entity to be used as a means to carry out fraud or evade tax, i.e. the business purpose test shall be satisfied.

(ii)    India has a "judicial anti-avoidance rule" which allows the revenue authorities to invoke "substance over form" or "pierce the corporate veil" if it discharges its burden of establishing that the transaction in which the corporate entity is used is a "sham or tax avoidant". The lack of business purpose must not be a result of dissecting the legal form of a transaction. An investor shall be looked at in a holistic manner keeping in mind the following factors: (i) participation in investment, (ii) duration of existence of holding structure (prior to acquisition), (iii) period of business operations in India, (iv) generation of taxable revenues in India, (v) timing of exit and (vi) continuity of business on exit.

(c)    Situs of capital asset in India:

(i)    For taxation in case of transfer of capital asset in India, three elements shall exist: transfer, existence of a capital asset and situation in India. Section 9(1)(i) of the Income Tax Act, 1961 (I-T Act) does not cover indirect transfers.

(ii)    Controlling interest is not a separate capital asset.

(iii)    Section  9 of the I-T Act covers  only  income  arising  from  a  transfer  of  a capital  asset  situated  in  India  and  it  does  not  purport  to cover  income  arising  from  the  indirect  transfer  of  capital asset in India. This section does not have any "look through provision".

(d)    Observation on the Mauritius route:

In the absence of a 'Limitation on Benefits' clause in the Indian-Mauritius DTAA, the court upheld the sufficiency of TRC in order to avail the benefits under the Mauritius Treaty. However, taking a step further from the Azadi Bachao case, the court also recognized the situations where the TRC can be ignored:

(i)    Where there is no commercial substance and Mauritius entity has been made out to be the owner of the capital asset in India only to avoid taxation;

(ii)    Where the treaty is used with a fraudulent purpose of evasion of tax;

(iii)    Where round tripping can be established.

Retrospectivity of Section 9 of the I-T Act

The Finance Bill introduces retrospective amendments in Section 9 of the I-T Act. Section 9, it may be noted, deals with income accruing or arising in India. Indian taxation laws work on a residence cum territorial model of taxation whereby, in case of residents, global income is charged to tax, and in case of non-residents, income accruing or arising in India is taxable.

To put the proposed amendment of the I-T Act succinctly, it means to say that if a transfer of a share or other interest in a company or entity has taken place out of India, but the value of the share or unit depends primarily on assets in India, then income arising from sale of such share or unit shall be deemed to accrue or arise in India. Vodafone was using international holding companies for shifting the tax base out of India. There is no doubt that the assets with reference to which Vodafone acquired Indian telephony business were all Indian subscribers. But the transfer took place in shares of offshore holding companies. The proposed amendment would mean, Vodafone will be called upon to pay taxes to the tune of Rs12,000 crore. Of course, there will be a question of additional taxes, penalty and interest.

The proposed amendment will not be limited to Vodafone. Hundreds of holding company transfers that take place out of India will all be subjected to tax in India.

Taken to its extension, transfer of all depository receipts out of India pertain to assets in India-as the GDRs/ ADRs are nothing but proxies of shares. Hence, all such transfers also become taxable in India. However outrageous this may seem, all those non-residents who hold GDRs and ADRs in Indian companies may be slapped with tax liability in India. Those may be difficult to catch-as they are not subjected to the jurisdiction of the tax officers in India, but what about transfers of participatory notes, and other similar instruments issued by FIIs? They all derive their value from assets in India.

Summary and concluding remarks

In the author's view, it was quite logical for the tax authorities to write a substance-over-form rule-which is what courts in UK such as Indofood International Finance have done. The approach should have been to give recognition to the substance over form rule. However, what has been done in Section 9 is travel back in time machine, and travel wide to the world at large, and catch all transactions all over the world, that have bargained Indian assets over last 50 years ! Hats off to the imaginative and ambitious person who might have drafted the clause!
(The author can be contacted at [email protected])  



A Banerjee

5 years ago

If the country's sovereign interests are at stake as much as its rightful revenues, there can be nothing wrong in retrospective amendments. It is true, though, that the administration of the Income-tax Act is not that quasi judicial as it is made to believe and, in fact, it is entirely adminitered by the politicians and bureaucrats, but in the instant case it was India's revenue that was lost and some foreigners were allowed unjust enrichment at the cost of our people.


5 years ago

This ammendment/clarification, though retrospective for 50 years, is also however, governed by IT Act that only allows retrospective opening of cases, for maximum 6 years. Author, Soma Bagria, seems to have missed this out. This provision still stands. This has even been clarified by the FM in post budget interviews but in all the emotional arguments, people mention only 50 years (erroniously) as period for reassessment. Vodaphone is within the 6 year limit.

My own prefference is strongly that there is no retrospective effect on tax laws for imposing additional taxes. Maybe some day some positive change may be done with retrospective 6 year effect, that all will appreciate!


Vinod Kothari

In Reply to Mathai 5 years ago

They are now amending that provision too - extending the reopening period to 16 years.


In Reply to Vinod Kothari 5 years ago

The new 16 year period is now being put to cover only unauthorised accounts abroad. I presume that since black money parked abroad, is such a big emotive demand of opposition, Anna group, NGOs against corruption etc., presumably this specific provision should get wide support. Perhaps, people find it difficult to say that they support the government on any point! Is black money parked abroad to have immunity, if it has been over 6 years abroad?


In Reply to Vinod Kothari 5 years ago

Retrospective changes certainly is not good. however in the instant case, i am for one supporting the change, as we are talking about a national asset. It is the spirit that counts. It was necessary to create a foundation for recovery of ELIGIBLE taxes. I do not buy the argument of investor sentiments, as any investor who sees value in his investment, will certainly invest, regardless of the tax laws. All said and done, he sees only after tax profit.


5 years ago

Let me see if I understand this correctly:-

1) Somebody passing from in front of my house robbed me because the windowss were kept open to let fresh air in.

2) The insurance company and the police refused to entertain the complaint even though I had video evidence because instead they blamed me for leaving the windows open.

3) After a few years, the people who robbed me made a habit of it, and kept robbing me even though I tried to stop them. In fact, it appeared as though the police and insurance company were in league with the robbers.

4) Finally, tired of this robbery, I was able to make this an electoral issue, and so the politicians changed the rule with retrospective effect to catch the robbers and make them up for damages.

What is so wrong with that?

Yes, the robbers will go off elsewhere. Good.

Humbly submitted/VM

Nagesh Kini FCA

5 years ago

Thanks Soma for the brilliant elucidation of the retrospective amendment post-SC verdict in the Vodophone case.
No one challenges the right of the Government of the day to go for amending the law with retrospective effect - the bad precedent was set by Indira Gandhi!
Nani Palkhiwala had rightly said that Tax Planning is perfectly legally but tax avoidance is not.
When anyone makes effective use of the legal provisions as they stand enacted in the statutes of the day and enters into contractual obligations, more particularly when it is upheld by the highest court of the land in appeal, it does not warrant the Government of the day to go back 50 years into history to nullify the effect.
It'd be perfectly fine to amend the law prospectively or include specific provisions in the DTC that is hanging fire still.
I for one strongly hold it has to be strict NO-NO for the simple reason it tends to affect our credibility on the world economic stage - nothing but a Banana Republic that plays with the economic laws as it suits the times. at all conducive to long term planning both in the domestic and international business scenario.



In Reply to Nagesh Kini FCA 5 years ago

Opinions welcome. may be we were divided. Law is not mere letters. If some one is trying to misuse the system, do you call it tax planning. It is the spirit that counts. Supreme courts are not executive they go by the letters and not by the spirits. We have rightfully lost our share, when our own letters of the law only followed and not the spirits. It is our national asset that was traded, albeit between two non taxable entity. the question here, is not the letters of law, but the national asset. If Kasab, being a pakistani citizen, is not to be tried at our end, for the sins he is accused of, then it is mockery of our system. You can not trade in our assets without compensating us. This is what government says, and in my opinion, is in order. fifty years and all those are only flesh. On our losing international investors confidence, I feel is only cosmetic accusations. Let us understand, that money does not have boundaries. Excess money will go where high returns are offered. But then you have to pay the rightful share. Let us start building confidence in ourselves. Money will come if we work and no law can stop it.

p v maiya

5 years ago

Given a chance this FM and his advisors are capable of going back to mother's womb.The FM has in one stroke empowered the IT officials to re-open the cases on the ground of the 'intent of law' as now clarified with vengence. It is time we have a law of limitation even for Govt's claims. Otherwise, we become the laughing stock of the world


5 years ago

One certainly has the right to hold an opinion different from the decision taken by their lordships of the Supreme Court, but that in itself does not entitle the govt. to retrospectively amend the law.


Krishnaswami CVR

In Reply to Nadey 5 years ago

Amendments with retrospective effect is not uncommon. Recall the case of Indira Gandhi's election case. It is only the retrospective amendment that saved her. In this case the amendment is a prelude for appeal against the recent verdict.


5 years ago

To criticise is the hallmark of we Indians & the author of the article is no exception. It would be better if the author formulates provision to cover what she could have done to provide substance over Form.



In Reply to Rohit 5 years ago

You have practiced what you are saying about others. Other than a mindless critic like you the solution was obvious to all.
Honest Indians want clear rule of laws and proper, cogent interpretation. Not for tax officials to hound, harass and make up the rules as they go along. all that she says is that you cant go back in time to collect tax, that too after the SUPREME Court has ruled - and after crores of rupees have been spent on litigation.
At least vodafone had the money- smaller companies cant even fight because cost of litigation is prohibitive.

Vinod Kothari

In Reply to Rohit 5 years ago

Of course, the author has given what should have been done. The idea of the FM is to lay down the substance over form rule. It should have said - in determination of residence in case of special purpose vehicles, the law would adopt a see through approach to see the actual beneficial residence - rather than the legal domicile. The author does say what ought to have been done.

Krishnaswami CVR

5 years ago

Agree with the sentence in the last para:
" it was quite logical for the tax authorities to write a substance-over-form rule-which is what courts in UK such as Indofood International Finance have done. The approach should have been to give recognition to the substance over form rule."
Does this mean that the author agrees with the amendment? I am for one that the amendment is needed, but played smartly to cover a longer period, than being accused of targeting vodofone deal.



In Reply to Krishnaswami CVR 5 years ago

Clearly the amendment was expected ,given that large amounts were at stake.I agree with you that the govt tried covering its tracks to not seem targeting Vodafone; very poorly though! Perhaps in the rules or notification Govt might restrict review over the last 3/5 years, out of pragmatism or to avoid excessive criticism.

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