The budget announcement on February 1, impacted sentiments of the equity investors negatively as they have to pay a 10% tax on long-term gains made from equities, which were earlier tax-free. The reintroduction of long-term capital gains tax is a sensible move. Equities remain the most efficient asset class for investors looking to grow their capital over long periods of time, as they provide higher growth and at still lower tax rates as compared to other asset classes.
But there are various concerns among investors:
- STCG and LTCG
Investors? concerns as why to invest for long term in equities, since difference between STCG & LTCG is only 5%.
Equities have delivered approximately 16 per cent CAGR returns created wealth in the long run; satisfying long-term investors. However, short run equity markets fluctuate drastically, sometimes going negative too. Some short term traders/ investors may make money, while most others lose money. There are so many instances of investors not coming back to stock markets because they lost money, and most of them were short term investors. ?Simply put, the likelihood of making money in the long run is definitely high, compared to making money in the short run. Hence, do not complicate things by looking at tax rate in this regard.
- Equities has lost its preferential tax treatment
Equities has created long term wealth. Remaining invested in equities for the long term, has made so many people rich. A well-known equity index S&P BSE Sensex has delivered fantastic long term returns of approximately 16 per cent CAGR returns since inception in 1979. In India, actively-managed funds have beaten the equity indices by a margin, making returns even more fantastic.
Let us understand the impact of LTCG tax on equity investments with the help of an example.
If someone invests Rs1 lakh today. He holds his investment for 10 years and it generates 16 per cent CAGR returns (same as historical equity index returns). After 10 years, he accumulates around Rs4.41 lakh from his investment, a growth of 4.41 times in 10 years.
If he sells his investment that year, he will have to pay LTCG tax at 10 per cent, amounting to Rs 24 thousands (10% tax on 2.41 lakhs). Considering Rs1 lakh LTCG is exempt, his post tax gains will amount to approx. Rs.3.17 lakh; 3.17 times return on original investment. That’s absolutely wonderful, a 15.35% per cent CAGR return on the initial investment in the long run. Equity is the only asset which can benefit from compounding in a meaningful way and need to be part of asset allocation in majority of cases.
- Best Investment Instrument
Despite the LTCG, an equity still remain best investment instrument for long-term wealth generation. The tax rate on LTCG on equity shares and equity mutual funds is 10 per cent, which was nil earlier. Even after a 10% tax on your long-term capital gains, equity investing have the potential to outperform returns from most other savings and investment schemes available in India.
If we look at other investment options, in most cases returns are taxable as per tax slab, which implies if you happen to be in 30 per cent tax bracket, you will have to pay 30 per cent tax. While in some investments LTCG is 20 per cent with indexation benefit. Hence, equities are still receiving a preferential tax treatment (even if LTCG is taxed at 10 per cent), compared to most other investment avenues.
- LTCG and Grandfather Clause
Equity will not be miserable since it has been implemented with grandfather clause to protect existing investors. Under this clause, the price of the security on January 31, 2018 is the benchmark date. If a taxpayer has acquired listed shares or equity funds before 31 January 2018, all the long-term capital gains he has made on them will remain tax-free for all future years. In short, these past gains have been ?grandfathered? for the taxpayer. The extent of gains (or losses) will be calculated based on two things: your cost of acquisition and the highest traded price for the stock as of January 31, 2018. If the price on this date is greater than the original buy price, January 31 price is then considered as the buy price for estimating capital gains when the security is eventually sold, thereby softening the tax payments for investors (if sell price is lower than January 31 price, yet higher than original buy price, the sell price is taken as buy price, thus making capital gains for tax purposes zero). Equity still remains the lowest taxed investment and LTCG tax will not impact the growing equity and SIP culture amongst retail investors.
- Benefit to Government
Two important effects of Introduction of LTCG. First, those investors having profitable positions would try to exit the markets in the short run before March 31, 2018 to avoid paying the double taxes. Potentially, investors can sell gains amounting to Rs1 lakh and below and repurchase it immediately. This sell-buy strategy can be timed such that any net loss on the transaction is lesser than the LTCG tax.
On the other hand, the long-term investors would hold their positions, awaiting favorable exit positions in terms of gains or tax regimes. The real fatalities here are those middle investors whose gains are more than Rs.1 lakh but not very high. Thus, the Government may not generate anticipated revenue due to short term selling, long term holding of positions and slower entry of new investors.
So, as there is a new LTCG tax of 10% on equities and equity oriented mutual funds, still it is the one of the highest return investment class available in the market. So there may not any adverse impact on the flow of equity investments in the near future.