It was day of the budget, all eyes on what our respected Finance Minister Mr. Arun Jaitley had to offer to the citizens of India, rumors were already in the market that LTGC (Long Term Capital Gains Tax) may come back to haunt investors. Then, a bomb was dropped 10% tax on capital gains from stock market, the market started bleeding profusely, Looked like the party was over the hopes and opportunities of making millions from the market are gone forever. No one can make money now…Oh lord! What would the poor investors do? Hold on. Before we make any assumptions about the tax policy, let us understand it completely and weigh its pros and cons.
Here is what happened
On 1st Feb 2018, Finance Minister Arun Jaitley announced ?the budget where LTCG tax (tax applicable on the sale of stocks after holding for one year or more) was reintroduced after more than a decade long exemption. The tax will effective from April 1st, 2018, and will be applicable on capital gains exceeding Rs.1,00,000.
LTCG: The history:
Tax on long term capital gains are nothing new for the Indian stock market. Before Sept 30th 2004, the Long Term Capital Gains from sale of stocks was 20% of the total gains/profit from the shares. Post 2004, all the shares purchased through recognized stock exchange, were exempt from LTCG if the holding period was more than 12 months.
To balance the revenue loss, a new tax called STT(Securities Transaction Tax) of 0.1% was introduced on all the purchase and sale of stocks on the total amount of transaction. For example, if you bought or sold stock worth Rs. 100,000, you had to pay 0.1% of this (which is Rs.100) as STT which was automatically deducted at the time of placing the order.This tax was simple and had no administrative expenses.
LTCG: current scenario:
There are two different scenarios in which current tax system will work. First is pre-31st March 2018 and second is post 31st March 2018.
Since the new tax policy is effective from 1st April 2018, the investors holding stocks for more than one year can still claim this tax benefit if they sell their holdings before 31st March 2018.
For the transactions after 31st March, 2018, there is still exemption for the capital gains upto Rs.1,00,000. In other words, if you sell your shares after 31st March 2018 and if total capital gains from sale of shares is less than Rs. 1,00,000, you will not be paying any tax. For example, if your total capital gains for the financial year 2018-19 is Rs. 1,50,000, you will pay 10% tax only on the amount exceeding Rs.1,00,000, which in our case is Rs.50,000. So this is how things will be for you in case of above mentioned scenario.
Your total Capital Gains for FY 2018-19 Rs. 1,50,000
Your total tax exemption for FY 2018-19 Rs.1,00,000
Your total Taxable amount for FY 2018-19 Rs. 50,000(1,50,000-1,00,000=50,000)
Total tax to be LTCG paid by you for FY 2018-19= Rs. 5,000 (10%* 50,000)
Effectively, you pay a tax of Rs. 5,000 on a capital gains of Rs. 150,000.
The markets are vehicles of long term investment, where investment horizons stretch from 5 years to 15-20 years or more. Historical data shows, that if someone is willing to invest in market for such a long period of time, there is not much to worry about tax as it will form a small portion of the entire corpus received by the investor.
What triggered the sell off?
Many investors still believe that market sell off was a result of introduction of long term capital gains tax. But there was something else that was responsible for such a market fall.
If you were tracking global markets closely, you might have noticed there was a sharp fall in the US market as well.
The reason behind such a sell off in US was the job report published by the US labour department which indicated that there was a rise in number of jobs and wages in the month of January. While 200,000 jobs were added in a month, the wages rose by 2.9%, one of the highest since 2009.
On the surface this sounds like good news, but on a deeper examination, the story is completely different. Higher jobs and rise in wages means people will have more disposable income in hands, which would lead to rise in inflation.
As the inflation peaks, it is the duty of Federal Reserves to keep inflation rate under control for which it has to raise interest rates. Higher interest rates means that companies had to pay more ?to service their debt, which leads to lower profitability of its shareholders.
The fear of higher interest rate caused market nervousness, and triggered a global selloff across the Asian and European market. ?
So it was not just the introduction of LTCG that caused the market meltdown, it was the expected increase in interest rates in US that was a major contributor to the overall global and domestic market correction.
Should you worry?
The biggest question now is what will be the market direction for coming few days and how will it impact short term and long term investors? I had a conversation with many analysts and most of them were expecting a correction from a long time. As mentioned earlier, the entire sell off is an exercise to book long term profits before 31st March 2018 and avoid paying LTCG tax as per new tax policy.
In my opinion, the market will see such a sell of till 31st March 2018. After this, the market will see some stability. New investors, looking to invest in stocks for a long term can use this sell off to buy quality companies at a fair price. There is no reason to predict why the markets will not do well in the coming 3 or 5 years, and if you are willing to stay calm during this storm, there is a good chance that you will end up making some handsome gains in the future.