Budget: Action plan for investors

With the market on a purple patch and the government too looking for additional revenues, long-term capital gains (LTCG) tax on equities is not a total surprise. From April 1, 2018, for listed equity shares, units in equity-oriented mutual funds and equity fund-of-funds sold after one year of holding, a long-term capital gains (LTCG) tax of 10 per cent will be charged on gains in excess of ₹1 lakh. To bring parity between those opting for growth and dividend options, dividends from equity funds will also be taxed at 10 per cent.

The tax will be deducted by the mutual fund houses before paying out the dividends, similar to the current process adopted for dividends from debt funds. Debt funds attract a 25 per cent ‘dividend distribution tax’ (28.8 per cent including surcharge and cess for this fiscal).

According to fund houses we spoke to, the 10 per cent tax on equity fund dividends can be called a ‘dividend distribution tax’ for all practical purposes.

But it is not clear whether there will be a surcharge and cess above this. If yes, the tax cut could be higher. Tax on LTCG will not be applicable on gains made till the date of announcement of this move. The general understanding is that the ₹1 lakh limit is on the aggregate long-term gains made in one year by a tax payer and not on every individual sale. But this is not mentioned specifically in the budget documents.

Investors can take solace from the fact that this tax is not applicable retrospectively. Small investors need not fret too as only gains over ₹1 lakh in a year will be taxed. Investors in Equity Linked Savings Schemes for the purpose of claiming tax deduction under Sec 80C should note that their investments now lose the ‘Exempt Exempt Exempt’ (EEE) status.

Losses can be set off

Unlike the Securities Transaction Tax (STT), which is paid irrespective of whether you have made profits or not, LTCG tax will be paid only on gains, that too above ₹1 lakh. Also, when the markets are bearish, the LTCG tax can help investors set off their losses in one year against gains in another year. This set-off facility is not available under the current regime as the gains are exempt from tax.

Growth option attractive

Fund houses may declare dividends quite a few times in a year and multiple times in the period during which you hold a fund. Every time it does, dividends will be paid out to you after the deduction of tax. But you may not sell units every year and even if you do, your gains may not exceed ₹1 lakh. Thus, for investors whose LTCG in a year don’t exceed ₹1 lakh, the dividend option is no longer attractive. Choosing the growth option makes more sense.

SWPs score

Tax on equity dividends implies that investors will now have less incentive to invest in equity-oriented funds for the purpose of regular dividends. In the booming market conditions in the last one year or so, equity-oriented balanced funds and arbitrage funds have been sold on the premise that they can provide a regular monthly income in the form of dividends. In reality, fund houses can pay dividends only out of surplus, be it a debt fund or equity fund. Even that is not mandatory.

During bearish market conditions, they may not be able to declare dividends at all. Two, even if some funds declare dividends more frequently than others, what investors get in hand will be net of tax and hence, lower than the declared dividend. But the net asset value (NAV) of the fund will be adjusted for the gross amount.

A comforting factor for investors who want to choose the dividend option in equity funds despite all the spokes in the wheel is that the dividend distribution tax is only 10 per cent here, while for debt funds it is much higher. But for regular income purposes, opting for Systematic Withdrawal Plans (SWP) in an equity fund after a year of investment is a better option.

Lower churn

A smaller implication of the LTCG tax on equities is that investors may now have to think twice before churning their mutual fund portfolio often, as it will involve a cost. While there is no denying that you should quit consistent underperformers, going in and out of funds in the hope of riding on the top performers of every season, may not be a good idea. A topper of one season which is not well-managed may end up being a laggard in the next. Consistency in returns across market cycles matters more for long-term investors.

Long-term benefits intact

Holdings in debt fund over three years already attract a LTCG tax of 20 per cent (with indexation benefits). For investors with low risk tolerance who took to equity funds for the sole purpose of the tax-free nature of long-term gains so far, the move now warrants a re-look at their asset allocation. The choice of savings instruments should be based on risk appetite and time available to reach the financial goal rather than taxation benefits alone.

According to fund managers we spoke to, for investors who have a higher risk appetite, equity funds still retain their edge, despite the lack of inflation indexation benefits. Non-availability of indexation benefits may probably increase the absolute tax outgo for equity funds over debt funds. But a back of the envelope calculation shows that this will not dent the ability of equity funds to outperform debt funds over a long time-frame of, say, ten years. This calculation assumes a return of 10 per cent (compounded) for equity funds, 7 per cent (compounded) for debt funds and an average inflation rate of 5 per cent, which are all reasonable numbers.

Hence, long-term investors who have ongoing SIPs in equity funds towards goals such as children’s higher education, marriage and retirement need not panic. The SIPs can continue.

Salaried taxpayers have little to gain

BY ANAND KALYANARAMAN

“Expectations are always the cause of misery”, reminded Finance Secretary Hasmukh Adhia in a post-Budget interview. Individual taxpayers who had high expectations have reason to be disappointed with Budget 2018.

Pretty little has changed and their high hopes of big tax breaks have remained just that. The Finance Minister did not make any change in the structure of income tax for individuals. He gave some relief, only to nullify most of it.

Here’s how. Conceding a widely voiced demand, the Budget has allowed standard deduction on salary income up to ₹40,000.

But then out goes the tax exemption on medical expense reimbursement (₹15,000) and transport allowance (₹19,200) — totalling ₹34,200. In effect, the taxable income reduces by just ₹5,800 a year for salary earners who get medical and transport allowance.

This group generally comprises those below 60 years of age. On the reduced tax income of ₹5,800, the tax benefit, excluding cess, is the range of ₹290 (for those in the lowest 5 per cent slab) to ₹1,740 (for those in the highest 30 per cent slab). And this little benefit too is chipped away by the increase in cess on total tax.

Education cess, currently 3 per cent of tax, has been replaced with Health and Education cess of 4 per cent of tax.

The outgo due to higher cess could, in fact, be more than the tax saved in the case of high salary earners, resulting in net tax outgo. For instance, for a salaried individual less than 60 years old earning ₹18 lakh a year, investing ₹1.5 lakh in Section 80C tax-saving instruments and paying health insurance premium of ₹25,000 eligible for tax break under Section 80D, the tax outgo will increase by ₹1,190 after Budget 2018.

Benefit of standard deduction

The tax benefit though is better for salaried taxpayers who do not get medical and transport allowance. This group generally comprises those aged 60 or more and earning pension income. With no disadvantage from removal of tax exemption on medical and transport allowance, the entire benefit of standard deduction of ₹40,000 would be available to such taxpayers. This works out to tax saving of ₹2,000 (for those in the 5 per cent slab) to ₹12,000 (for those in the 30 per cent slab) excluding cess. But here too, the benefit is reduced by the increase in cess on total tax. Thankfully, for the elderly aged 60 and more, the Budget has provided other tangible sops too — in the form of higher tax breaks on interest incomes and health insurance among other benefits (see accompanying story).

Hopes belied

For those below 60 though, big hopes have been left unmet, yet again. There was expectation of increase in the tax exemption limit (currently ₹2.5 lakh for those under 60, ₹3 lakh for those aged 60 up to 80, and ₹5 lakh for those aged 80 and more). Individual taxpayers also expected increase in the Section 80C investment limit (currently ₹1.5 lakh), higher tax breaks on medical reimbursement and children’s education allowance, and increase in tax deduction on interest payment on home loans (₹2 lakh). The last major tax breaks were given nearly four years back in the July 2014 Budget and inflation has eroded the benefits. Besides, with many state elections scheduled this year and the 2019 general election just about a year away, taxpayers were betting on the Government loosening its purse strings. But that was not to be.