The move by the Centre to bring back Long Term Capital Gains tax on equity shares and equity-oriented mutual funds is a step in the right direction as it reduces the disparity that currently exists in the tax treatment of equity and other investment classes such as debt. While there was a steep sell-off in the stock market on Friday, the finance minister needs to stand firm and resist pressure to roll back the move. There could be short-term volatility in market; however this move will have a positive effect on investor behaviour. The preferential treatment meted out to equity, with no tax on gains made on shares held for more than one year, had resulted in a skew in the investing pattern, with more money flowing into the stock market, exposing investors to higher risk. Also it was hurting manufacturing companies that raise capital through debt and other instruments, by depressing the demand for these instruments. The Centre was also losing revenue through this leeway; it could have raised ₹36,700 crore, had the capital gains made in 2017-18 been taxed at the rate of 10 per cent.
By taxing gains above ₹1 lakh, the finance minister has ensured that small investors do not come under the ambit of this tax. He has also been considerate to investors holding stocks or mutual funds with large unrealised gains by stating that the cost of the stock could be taken as the highest traded price on January 31. This implies that profits made until the end of January, on shares or equity mutual funds that have been held for more than one year, will not be taxed. While this averts retrospective taxation, this relaxation could roil the stock market in the immediate future. Stock prices surging ceaselessly over the last few months, coupled with weak earnings growth, have made valuations very pricey. Investors are therefore quite nervous, anticipating a correction. By locking the gains at the highest traded price on January 31, the finance minister has limited further rally as stock price increases in the next two months will bring on profit booking to avert payment of LTCG in future.
The finance minister could have averted this situation by making the new tax on long term gains applicable from February 1, 2018. This could have averted selling pressure in the next two months, before the new rules are implemented. The finance minister should also consider allowing indexation of cost of shares and equity-oriented mutual funds for calculating long-term gains, in line with other assets. Else long-term investors in equity and equity mutual funds will be disincentivised from holding on for the long term.
Published on February 02, 2018
via Long overdue – Business Line