[Model Answer] UPSC GSM3-2018/Q2: Long-term Capital Gains Tax (LCGT) & Dividend Distribution Tax (DDT) in the Union Budget

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  1. Question for GS3
  2. Introduction (Origin / Define)
  3. Conclusion (Welcome the Budget!)
  4. Afterthoughts / Pitfalls / Mistakes

Question for GS3

Q. Comment on the important changes introduced in respect of the Long-term Capital Gains Tax (LCGT) and Dividend Distribution Tax (DDT) in the Union Budget for 2018-2019. (150 words, 10 marks, asked in UPSC Mains GS3-2018)

केंद्रीय बजेट 2018-2019 में दिर्धकालिक पूँजी अभिलाभ कर (एल. सी. जी. टी.) तथा लाभांश वितरण कर (डी. डी. टी.) के सबंध में प्रारंभ किए गए महत्वपूर्ण परिवर्तनों पर टिप्पणी कीजिए।

Relevance to Syllabus of UPSC GSM3: Government Budgeting.

Introduction (Origin / Define)

  • (Origin) Under the 7th Schedule of our Constitution, the Union is empowered to levy taxes on income other than agriculture- such as Corporation Tax, Personal Income Tax, Hotel Receipt Tax, Interest Tax, Fringe Benefit Tax, Capital Gains Tax (CGT), Dividend Distribution Tax (DDT)…. (OR)
  • (Define) Under the Indian taxation system,
    • Capital Gain Tax (CGT) is levied on any profit arising from sale of ‘Capital Asset’. Depending on the length / duration of the ownership before selling of the asset, this tax is further divided into 1) Long term CGT and 2) Short term CGT.
    • Dividend Distribution Tax (DDT) is levied on the amount of profits paid by the company in the form of dividends to its shareholders.

Example of Poor introductions: giving “origin” of Budget under Article 112. or that taxes are levied for public welfare. Your introduction’s spotlight should be the two taxes asked in question. Don’t start bowling from outside the stadium.

The notable changes in the LCGT and DDT made under Budget 2018-19 are as following:

Long-term Capital Gains Tax (LCGT) and Dividend Distribution Tax (DDT)

Body#1: Changes in Long-term Capital Gains Tax (LCGT)

  • Until now, if an investor sold his shares / (equity) Mutual Fund units after holding it for a period longer than 12 months then his profits were not subjected to Long term capital gains tax.
  • Finance Minister observed that the profits made from such activities were over Rs.3.60 lakh crores per year. And majority of this profit was cornered by large corporates and high net worth individuals (HNI).
  • So, if such profits were subjected to LCGT, then it could augment the fiscal resources of the Government.
  • But, at the same time, excessive taxation could discourage retail and small investors from participating in the Share Market and Mutual Fund.
  • Therefore, to balance both aspects, Budget-2018 announced to levy 10% LCGT on profit exceeding Rs. 1 lakh during the sale of shares (equities) & equity mutual funds.
  • No need to explain the “grandfathering clause” or how this LCGT applies on units of Business Trust. You’re appearing for Civil services not Chartered Accountant Exam.
  • It’s better use the word “equities” instead of “shares”.
  • Mutual funds also have different types depending on where they invest money e.g. Debt-MF in bonds, equity-MF in shares etc. You can pad the answer by such explanations IF you don’t have content on exact budget changes.

Body#2: Changes in Dividend Distribution Tax (DDT)

Dividend Distribution Tax (DDT) is levied on the dividend paid by the company to its shareholders. Two major changes were made here in Budget 2018-19

  1. Previously Equity Mutual Fund distributing income to its investors, were not subject to DDT. Now they’re subjected to 10% DDT.
  2. MNCs and local unscrupulous companies would announce merger / amalgamations of their profit making subsidiary company with loss making subsidiary company, in order to reduce their DDT liabilities to promoters. To reduce the tax-avoidance through this loophole, Budget-2018 made certain technical changes in the computation of Dividend Distribution Tax (DDT). (#)

(#)How company avoided DDT and how new rules curb it? It’s not worth the time and effort of learning and explaining. Just gist is enough.

Conclusion (Welcome the Budget!)

  • Thus, the aforementioned changes in LCGT and DDT are aimed at improving revenue collection / fiscal resources for the government and reducing the tax-avoidance opportunities for the unscrupulous companies. (OR)
  • A good taxation system should exhibit “progressivity” i.e. those with higher incomes should taxed at higher rates. However, the previous system exempted even rich persons’ profits from LCGT, and helped companies / promoters to dodge the DDT. Budget-2018 has taken appreciative reforms to address these issues.

In other words, previously from 0% LCGT & 0% DDT atleast now these rich people have to pay 10% tax which is “progressivity”.

Afterthoughts / Pitfalls / Mistakes

  • Body#1 (why LCGT was reformed) is available in Finance Minister’s budget speech. However, Body#2 (DDT related things) not explicitly explained / mentioned in the budget speech. So, I had to refer to business newspapers’ articles.
  • Such technical taxation questions were not asked in previous mains. This question is designed only to raise stress in exam hall. You’re not expected to solve it, besides, given the limited time vs large number of questions, you can never attempt all 20 questions in best manner. So, this question should be seen as a ‘test to see your ability to prioritize the attemptable questions.’
  • While it’s not possible to recall the exact changes, but if you know that it was mainly dealing with mutual funds then you can try to concoct a ragtag answer with keywords like “fiscal resources”, “fiscal capacity”, “tax avoidance” .
  • Avoid wrong keywords like “Tax EVASION”. Evasion means hiding transaction and not paying tax like a criminal, whereas avoidance means disclosing the transaction to authorities but using legal-loopholes to pay less tax- which is ‘unethical’ but not ‘legally-criminal’
  • Avoid writing an Essay on how taxation helps in public welfare.
  • Avoid completely wrong guesses like “LCGT and DDT reforms were made to comply with GAAR / OECD / FATF norms / Arbind Modi panel on direct taxes.”
  • To learn more about Mutual Fund types watch my lecture, and to learn more about direct taxes theory watch my lecture.

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4 Comments on “[Model Answer] UPSC GSM3-2018/Q2: Long-term Capital Gains Tax (LCGT) & Dividend Distribution Tax (DDT) in the Union Budget”

  1. Excellent

  2. Sir suggest books for RBI exam

  3. 👌👌

  4. It was very useful for mains preparation ..thanks for your indetailed explaination.

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