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Budget 2018: How will change in capital gains tax structure affect markets?     January 23, 2018

According to reports on budget expectations, the government is considering to increase the tenure of short term capital gains (STCG) by over 2 years in the Union Budget that will be presented on 1st February 2018.  The move will help the government to bolster its revenues from the equity markets. The government is believed to be losing nearly Rs 50,000 crores every year due to exemption of long term capital gains tax.

Currently, short term capital gains are charged at 15%, if the holding period is less than one year and long term capital gains (LTCG) are tax free (if shares are sold after one year from the date of purchase). The government also charges securities transaction tax (STT) on every purchase and sale of listed shares. In addition, there is dividend distribution tax that is charged on companies that declare dividends and an additional 10% tax if the dividend income exceeds Rs 10 lakhs.

Experts believe that government would either remove the distinction between tax on long-and short-term capital gains or will increase the holding period for STCG to three years from one year. Investors will have to hold equities for more than three years for availing the benefits of long term capital gains.  

The bull run of stock markets may halt in the short run, if such speculations become a reality in the upcoming budget. The current bull run could be a leading indicator of revival in economic growth and investment activity. However, the growth may suffer in case the markets react negatively to such change in tax structure.

The other argument that goes against taxing long-term capital gains is the effect on capital formation. Capital formation is an important driver of economic growth. Taxing capital gains tax are likely to distract investors from equities which will negatively affect capital formation. FPI inflows could also reverse if the holding period of LTCG goes up.

Although, Indian markets are now supported by domestic liquidity and domestic institutional investors like banks, insurance companies and mutual funds, the correction cannot be ruled out in the short-run if the government tweaks the capital gains tax structure.

Some experts believe that STT will be abolished or government will allow participants to set off STT against LTCG. Such measures if allowed will provide relief to the investors who will consider tax on capital gains a disincentive to invest in equities.


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