The introduction of Long-term Capital Gains Tax (LTCG) was pretty much factored in by the markets in the run-up to the budget. Yet there was a quick negative reaction when Finance Minister Arun Jaitley announced a 10 percent LTCG. The Sensex, which is in the heat of a bull run, sank 450 points after the announcement was made.
For retail investors, the move takes away one of the most immediate rewards of equity investment -- the tax free returns if the investment is held for more than a year. The long-term capital gains tax was scrapped in 2005 as the dominant view was that higher participation in equity investment was needed.
Will the re-introduction of LTCG have a tempering effect on the overheating stock markets? Where will the money flow even as investments in stocks are getting saddled with higher taxes in the future? Which sectors stand to gain? What will be the impact on investments in the mutual funds, which has seen a phenomenal rise in recent months?
As per the budget proposals, LTCG over 1 lakh in a year will attract tax of 10 percent while short term capital gains remains at 15 percent. The capital gains accrued before January 31, 2018 will be exempted. Jaitley said this "modest changes" in taxations in equity returns will bring in a marginal revenue of Rs 20,000 crore in 2018-19. In perspective, a total amount Rs 3.67 lakh crore had been exempted from capital gains in 2017-18.
It remains to be seen if the return of the LTCG tax will impact retail investment in equities. The immediate impact of the measure on the mutual funds investment boom is also to be watched for.
The snap reaction to LTCG could be a sign of the raw nerves from this segment. It should be noted that the 2017 markets rally was propelled by retail investors and those who put in money into mutual funds through SIPs. The share of retail investors in equity markets in 2017 was Rs 153,310 crore, which dwarfed the Foreign Institutional Investment at Rs 51,252 crore. In comparison, net mutual fund investments in equity stood at Rs 115,837 crore.
The fact that the government hasn't withdrawn the Securities Transaction Tax (STT) is a dampener too, now that LTCG has been brought back. Also equity-oriented Mutual Funds will now attract a dividend distribution tax of 10 percent, something that retail investors will have to take stock of.
However, the re-introduction of LTCG will help a resurgence in other investment avenues, mainly realty, experts say. "Change in capital gains tax for equity could accelerate the shift of preference from equity to other investment assets like Real Estate. This would be a reversal of the trend we have seen the last 5 years. More investment could start to real estate," said Joe Verghese, Managing Director, Colliers International India.
Markets recouped the initial losses on Thursday. The BSE Sensex had fallen below 36,000 following the LTCG announcement and Nifty sank below 11,000. However both indices regained those levels in afternoon trade.