The Union Government in its wisdom, introduced a Long Term Capital Gain (LTCG) tax on equity shares in its budget for the financial year 2018-19. My attempt in this blog is to elaborate on how should investors respond to the introduction of this tax.
The words in the detailed text regarding the tax rate in the finance bill are as follows:
The tax payable by the assessee on the total income referred to in sub-section (1) shall be the aggregate of—
(i) the amount of income-tax calculated on such long-term capital gains exceeding one lakh rupees at the rate of ten per cent.; and
(ii) the amount of income-tax payable on the balance amount of the total income as if such balance amount were the total income of the assessee:
The cost of acquisition for the purpose of computation of LTCG is :
(a) actual cost of acquisition and
(b) lower of
(i) fair market value of such asset or
(ii) full value of consideration on transfer.
“fair market value” means,-
(i) in a case where the capital asset is listed on any recognised stock exchange, the highest price of the capital asset quoted on such exchange on the 31st day of January, 2018: Provided that where there is no trading in such asset on such exchange on 31st day of January, 2018, the highest price of such asset on such exchange on a date immediately preceding the 31st day of January, 2018 when such asset was traded on such exchange shall be the fair market value;
(ii) in a case where the capital asset is a unit and is not listed on a recognised stock exchange, the net asset value of such asset as on the 31st day of January, 2018;
A few points follow from the above texts :
1. “Long Term” for equity is above one year
2. In a financial year Upto one lakh Rs of equity LTCG is tax exempt
3. For equity LTCG above one lakh Rs, the tax rate is 10%
4. All equity LTCG incurred till 31-Jan-18 can be grandfathered
5. Since now LTCG on equity is not exempt, LTCL(Long Term Capital Loss) in equity CAN be offset against LTCG. (This was previously not the case)
The consequences that follow from the above are :
1. When in gain, since the threshold for equity LTCG is one lakh Rs per annum, investors are well served to harvest equity LTCG to the extent of one lakh Rs per annum rather than incurring a one time equity LTCG significantly larger than one lakh Rs at the final point of sale. In other words every year sell and buy back equity such that one lakh Rs of equity LTCG is incurred without any tax.
2. When in loss, harvest the equity LTCL and file it in your returns. Use this harvested loss to offset all future LTCG (equity or not).
3. Significant incentive to move all debt fund schemes to growth option. On redemption of debt mutual funds under growth option all gain is capital gain (either long term or short term depending upon the tenure of the investment). This gain can be offset against long term and short term equity loss respectively and can significantly reduce tax incidence.
4. For those in the highest tax bracket, this gives a further incentive to move from fixed deposit schemes to liquid fund schemes. In fixed deposit schemes, interest received cannot be offset and is taxable at the marginal rate of tax in the hands of the investor. However in a liquid fund, short or long term capital gain can be offset against short or long term capital gains giving possibility of a tax shield.
5. Care must be taken that the amount of turn over incurred as a result of this increased activity is not construed as business income by the tax authorities. In other words turnover as a percentage of total capital assets must be small.
6. Care must be taken that the increased activity to save tax does not result in brokerage costs escalating to a point that the net impact is meaningless.
Do note that the above suggestions are generic in nature and for taking actions pertaining to a specific investor, the unique compulsions of the investor may require a more detailed analysis.