There currently seems to be a havoc in the markets and the reason is apparently owed to be the newly re-introduced tax (after 14 years) on Long Term Capital Gains tax (LTCG), as announced by Arun Jaitley in the Union Budget of 2018.
What is meant by LTCG or Long-Term Capital Gains?
LTCG is an abbreviation for Long-Term Capital Gains. It basically refers to any profit made on an investment held for a minimum of 12 months. Several other countries like Australia, China and Canada had already inculcated tax on LTCG into their financial systems a long time back.
Concept of grandfathering:
Grandfathering is a clause or regulation within a law which gives the luxury to any person or any businesses to not abide by that law. It is an alteration of the rule which allow any investor or investment technique to follow the old rule.
For example, suppose a stock is bought at 100rs in the last year (1st January 2017) and 31st January its price is 135rs. As per the government rule if your investment makes profit of 1lakh or more, you have to pay taxes on the money you have gained (Rs 35 per share). But, in this scenario, the taxes on the profit will not be applicable because of this grandfathering clause. It has been extended up to 31st January 2018, so after this given date, tax will be applicable as per the government tax’s rules.
Arun Jaitley introduced LTCG tax but…
The government tried to protect the interests of the investors by introducing tax only moderately (10%) and with the feature of grandfathering gains uptil 31st January, 2018. However, the fact that the prevalent STT (Securities Transaction Tax), which generates around 80 billion of revenue per annum for the Government, was not scrapped off even after introduction of LTCG tax was taken negatively by the markets. India is the only country in the world having both STT and LTCG, at the same time.
Points you need to know about the re-introduced LTCG Tax:
- Tax of 10% has been levied on gains of above one lakh rupees.
- For your existing stocks, the new cost price will become higher of your original purchase price or high of 31st January 2018. This implies that any long term capital gains as on 31st January will be grandfathered/exempt, applicable to both residents and non-resident investors.
- If existing shares held for more than a year are sold before 1st April 2018, no tax will be charged on the gains. This implies that the sale of shares held for one year, executed after April 1, 2018 will be taxed at 10%. This is probably the main cause of the prevalent panic selling environment as people are getting their one-time chance to lock in the profits made so far and escape LTCG tax.
- Short Term Capital Gains (STCG) tax has not been tampered with and continues to be 15%.
- Dividend Distribution Tax (DDT) has been introduced at 10% for dividend and balanced funds. This can lead to a shift to growth funds, where dividend is ploughed into the fund to buy new units.
- For non-residents at IFSC (International Financial Services Centre), STCG and LTCG tax in derivatives is exempt.
Basis behind the government’s move to introduce LTCG (Long-Term Capital Gains) tax
According to the Government of India,
- The No-LTCG tax regime was biased against manufacturing, encouraging diversion of investment in financial assets.
- LTCG exemptions created tax arbitration opportunities
- It led to a loss of revenue for the Governement to an amount almost equal to INR 490 billion per annum.
Presently, we are paying 10-30% tax on 6.5% return generated by FDs (Fixed deposits). Hence, paying 10% tax for an equity portfolio earning 15%, if it has been replicating the index (conservative approach) should not be much of a problem.
People can now open Demat accounts for each of their family members so as to divide and distribute the invested capital among more number of individuals, while at the same time dividing the gains. This can help many to stay within the the one lakh gains bracket and avoid Long Term Capital Gains tax.
Retail investor can also avoid taxes on Long Term Capital Gains by carry forwarding the losses. While filing your tax returns, show your losses along with the profits to negate the impact of LTCG tax. As we know LTCG is only applicable for equity, so it is advisable to try and invest in multiple asset classes.
A number of other tax and financial planning strategies can be learnt through the following course: NSE Academy Certified Financial Planning & Wealth Management