Budget 2018: LTCG tax on equities and equity mutual funds

Long-term capital gains (LTCG) tax is back. The finance minister announced in his budget speech that the long-term capital gains tax—arising out of the sale of equity-oriented mutual fund schemes as well as from direct equity shares—will now be taxed at the rate of 10%, if your cumulative capital gains exceed Rs1 lakh in a year. If such gains are less than Rs1 lakh in a financial year, then you are exempt from paying this tax.

At the moment, LTCG tax arising out the sale of equity mutual funds and direct equity shares is nil, if you have held the units or shares for at least one year. Budget 2018’s tax proposals say that the threshold for long-term capital gains, though, will continue to be 1 year.

The securities transaction tax (STT) of 0.001%, which unitholders of mutual funds pay at the time of selling and the STT paid at the time of buying and selling of direct equity shares (0.1% paid both at the time of buying as well as selling) will continue to be paid. Gautam Nayak, partner, CNK & Associates LLP, a tax firm, said, “The STT was introduced in place of capital gains tax, which was removed many years ago (in 2004). Now that the capital gains tax has been brought back in, the STT still remains.”

A bit of good news in this proposal is that the finance minister has allowed exemption of the gains that would have arisen up until 31 January 2018. Only the gains that would arise after 31 January 2018 would be considered.

To ensure that investors don’t switch to dividend plans, in order to escape paying the new 10% capital gains tax, the Budget 2018 has also introduced a dividend distribution tax of 10% for mutual funds. This is a tax what a fund house pays—from the distributable surplus—before it pays the dividend. Curiously, while the 10% capital gains tax is meant for only those investors whose cumulative capital gains are in excess of Rs1 lakh, the DDT will be borne by all investors of equity-oriented mutual funds.

But is it fair to make equity funds taxable when it was made tax-free (abolition of long-term capital gains taxes) so many years ago (2004, to be precise)? Shyam Sunder, managing director, PeakAlpha Investment Services Pvt. Ltd said, “From a macro point of view, it does seem justified. While stock market investors have become rich due to their equity share holdings, they continued to not pay tax. It was a bit of a sore thumb. If you look at the entire Budget 2018’s direction, I think it’s okay that some kind of tax parity is brought about.” Sunder says that equity investments are “bit less attractive now,” but he insists that equities still should be a part of an investor’s portfolio as part of her asset allocation.

Sunder says that a 10% long-term capital gains tax rate may induce some investors to churn before a year is over. “The short-term capital gains tax is 15%. Now, there is this LTCG of 10%. So within a year, if an investor has made sizeable gains, she could think of selling her gains and booking her profits by paying 15% taxes and then perhaps re-entering the markets later. She might think that instead of waiting for a year and paying 10% LTCG, she may as well sell now and pay 15% STCG and exit.”livemint