Nikunj Gandhi decodes the Long Term Capital Gains from Budget 2018 for our readers
Being the last budget of the ruling government, it was expected to be a populist budget and the finance minister did not disappoint the Indian masses on this front. However, the fears of equity investors did come true when the proposal was tabled to reintroduce the long term capital gains (LTCG) tax. Speculations were rife on days before the budget that the LTCG would be tweaked in favour of the exchequer to benefit from the windfall made by the investors in the charging bull market that shows no signs of taking a breather. However, the government did one better for itself by not only reintroducing the LTCG, but also by keeping the Securities Transaction Tax (STT) static. In the past, the STT was introduced as an alternative to the LTCG. Hence it came across as quite a blow to the investors when both the taxes prevailed in the budget speech causing a kneejerk reaction to the Sensex, which immediately tumbled upon fathoming this fact. However, semblance was restored once the grandfathering of gains (details explained below) was factored into consideration and normalcy reigned the quick recovery of the index.
The finance minister did not mince words in explaining his decision to bring back the LTCG and not tweaking the STT. The rationale was simple: With the LTCG being exempt so far, a substantial gain had accrued mostly to corporates and LLPs which created a bias against manufacturing and leading to more investments in financial assets. This would encourage investments in more economically productive activities. Also, the returns on investment in equity currently are quite attractive even without the LTCG exemption.
The only saving grace was the ‘grandfathering’ clause. The budget proposal was to tax all long-term capital gains exceeding Rs 100,000, @10% without allowing the benefit of indexation and all gains till January 31, 2018 will be grandfathered. Grandfathering, as a financial jargon, simply means an alteration of the rules that apply to a certain investment or investment technique while stipulating that investment actions taken before a certain date remain subject to the old rules, which precipitates into exemption from the new rule of gains in the previous period. The markets have accepted the 10% tax on LTCG because of the grandfathering of gains till January 31, 2018. However, the negative outcome from the continuation of STT and not providing the indexation benefit may be factored in later.
The proposal provides a few measures to be taken to circumvent the LTCG for now as per the following situations
- The new tax regime for LTCG will be effective from April 1, 2018. Hence, if the equity shares are sold before March 31, 2018 then LTCG exemption can be claimed
- For the equity shares sold after April 1, 2018, LTCG will be tax exempt up to Rs.100,000 per fiscal annum and 10% will be chargeable on the LTCG exceeding Rs.100,000
Now, if the sale happens after March 31, 2018 the LTCG will be taxed as follows:
- The cost of acquisition of the share bought before February1, 2018, will be the higher of
a) the actual cost of acquisition of the asset
b) The lower of: (i) The fair market value of this asset (highest price of share on January 31, 2018 or when share was last traded and (ii) The sale value received when the share is sold.
For example: Say if you bought a share for Rs100 and have held it for more than 12 months (to qualify for LTCG) and the fair market value of the share on January 31, 2018 is Rs 120 and you sell it for Rs 130 on June 1, 2018; then the cost of acquisition of this share would be Rs 120. You would have realised LTCG of Rs. 130 minus Rs 120, that is, Rs 10.
If you sold the share for Rs. 110 on June 1, 2018 then your cost of acquisition would be Rs. 110.
If you sold the share for Rs. 90 on June 1, 2018 then your cost of acquisition would be Rs. 100.
- Indexation of the cost of acquisition (determined as per above formula) will not be allowed. Setting off cost of transfer or improvement of the share will also not be allowed.
- Therefore, cost of acquisition is determined as per formula explained above, this cost will be subtracted from the sale value and the LTCG will be arrived at.
- This LTCG will be taxed at 10% for all listed equity shares where STT is paid on purchase and sale.
The impact is not as bad as first glance because of provision which allows the cost of acquisition to be taken at the market value on January 31, 2018. This is because this provision indexes the actual cost of acquisition up to this date despite removing the indexation of the actual cost of acquisition. This reduces the amount of capital gains that would face the 10% tax. Hence, for a sale after March 31, 2018, only the actual gains after December 31, 2018 would be taxed. However, a 10% tax has been levied on the capital gains calculated as above which was exempt in the earlier tax regime.
The booming markets have provided a big pie for the investors and the government wouldn’t want to lose out on an opportunity to dig into a piece of this pie. With the elections round the corner, this move shall be lauded as a populist stand for the common masses who can take respite in the feeling that the government is not pro-rich and in the face of capitalism, for once the proletariats prevailed over the tax exempted bourgeoisie.
Nikunj Gandhi is an Equity Investor and can be reached at email@example.com. These are his opinions and not necessarily of the newspaper’s.