The change

For shares and units in equity-oriented mutual funds sold after one year of holding, a long-term capital gains (LTCG) tax will now be chargeable at 10 per cent on gains of over ₹1 lakh. To bring parity between those opting for growth and dividend options in equity funds, dividends from equity-oriented mutual funds will also be taxed at 10 per cent.

This tax will be applicable prospectively. As per the Finance Minister’s example, if an equity share is purchased say on July 31, 2017 at ₹100 and the highest price quoted on January 31, 2018 for the same is ₹120, there will be no tax on the ₹20 gained so far if this share is sold after one year from the date of purchase (since the announcement has been made only on February 1, 2018). Any gain in excess of ₹20 earned after January 31, 2018 will be taxed at 10 per cent, if this share is sold after July 31, 2018. The gains from equity shares held up to one year will remain short-term capital gain and will continue to be taxed at the rate of 15 per cent.

The background

With the market on a purple patch and the government looking for additional revenues to balance the fisc, the LTCG tax on equities is not a total surprise. Equities have enjoyed pride of place among asset classes with capital gains on holdings of over one year being considered long-term and enjoying tax-free status. The move to remove this cult status has not come overnight.

The Direct Taxes Code, introduced by the UPA government, first mooted this proposal. A revised version of the Code (which lapsed with the dissolution of the UPA government in 2014), suggested an LTCG tax on equities but provided 100 per cent and 50 per cent deduction respectively for long- and short-term gains respectively, effectively making LTCG tax-free again.

The verdict

Every cloud has its silver lining. The good news is that this tax is not applicable retrospectively as explained above. Secondly, small investors need not fret too much as gains of over ₹1 lakh will be taxed. Going by the Budget speech, this move is targeted at corporates. According to the Finance Minister, tax-free LTCG on equities has created a bias against manufacturing, leading to more business surpluses being invested in financial assets.

Thirdly, unlike the Securities Transaction Tax (STT), which is paid by an investor irrespective of whether you have made profits or not, LTCG tax will be paid only on gains. Also, LTCG tax can help long-term investors set off their losses in one year, when the markets are bearish against gains in another year. This set-off facility is not available under the current regime.

The total amount of exempt capital gains from listed shares and units is around ₹3,67,000 crore as per returns filed for assessment year 2017-18. This change in capital gain tax will bring marginal revenue gains of about ₹20,000 crore in the first year. But these are years in which the markets have been on song. While this move could work well to mop up additional taxes in bull markets, it may not be of much help in bearish phases. Also, it remains to be seen if both STT and LTCG will exist side by side.

Takeaways

* Tax on long-term gains in stocks and equity funds

* Small investors not hurt much

* Set-off of long-term loss against long-term gains will now be available

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