There is an outside chance of long-term capital gains tax coming to equity
I remember the 2008 blockbuster Ghajini for its famous ‘short-term memory loss’ dialogue than anything else. The same seems to be the case when it comes to stock markets, people forget fast, which is bad and good, depending on which side you sit or view the developments. In recent weeks a lot of speculation has gone into how Finance Minister Arun Jaitley will tax investments in equities. The concern looming mostly among market participants is about the lock-in period on equity investments.
For those who recollect, in the interim Budget of 2014 Jaitley, raised the long-term capital tax on all debt funds to 20 per cent. Earlier, withdrawal from debt funds attracted a long-term capital gains tax of either 10 per cent (without indexation) or 20% (with indexation). In addition to this taxation, he also increased the threshold to claim long-term capital gains tax on debt fund investments to three years, from the earlier one year time frame. At that time, Jaitley did not touch equity funds’ taxation rules in his first budget.
Taxing equities
There seems to be a sense of anxiety as we are two weeks from the 2017 Union Budget that there is an outside chance of long-term capital gains tax coming to equity. Today, long-term capital gains on equity investments are nil and the lock-in is one year. When you invest in equities and sell your holdings after a year, the profits on the sale of such assets are called capital gains, which attract long-term capital gains tax.
Depending on the asset class such as bonds, gold, real estate or equities, the period of holding varies and so does the tax rates. In case of equities, the period of holding before long-term capital gains kicks in is a year, unlike other assets, where it is three years. It is not as though capital gains on equities never existed in the past, in fact till about 2003-4, there was long-term capital gain (LTCG) tax levied on equities. The idea of not levying LTCG tax was one of the recommendations of the Vijay Kelkar-led task force on direct taxes in 2002. Promptly, then Finance Minister, Jaswant Singh removed such a tax in a limited way in 2003-4 Budget, with the intention of reviewing the change the next year.
The next Finance Minister, P Chidambaram abolished LTCG tax altogether to encourage long-term investment and introduced the STT on trades, which would discourage frequent trading while minimizing loss of tax revenue. There are pros and cons to the STT as well as 1-year holding period in case of equity investments. There is a strong lobby that is seeking parity in the time duration of holdings in asset classes to be uniform, which could result in equity holdings to have a 3-year lock-in before levying LTCG.
Investor interest
If the 3-year lock-in is introduced, it will be good for the stock markets and also retail investors, who will then be forced to approach investments in equities with a longer time frame than the current one year that many adopt. This will also ensure that money managers will not be under undue pressure to churn their portfolios to manage redemptions by investors. More importantly, it will help small investors be patient with their investments and experience a long enough time in the markets to understand and experience equity investing. Will Jaitley touch the LTCG in case of equities will be known in two weeks from now, but for now, investors should take this change, if it comes in as a blessing. Of course, if LTCG is announced, there will be market commotion, but like Ghajini, it will have its own ‘short-term memory loss’ before things settle.