Market men are finding it difficult to come to terms with the reintroduction of long-term capital gains (LTCG) tax, which finance minister Arun Jaitley announced would be imposed on all gains of over Rs 1 lakh after January 1 on equities and units of equity-oriented funds. It is evident from comments of the finance ministry officials that the primary driver of this move seems to have been the need to garner additional resources, in a year when several factors could derail the budgetary math — from overestimating collections through GST and even securities transaction tax (STT). The government has also estimated for a sharp increase in STT to Rs 11,000 crore from under Rs 8,000 crore in FY18 revised estimates (RE), without any revision in rates. Given that 2017 was an excellent year for the markets, expecting 2018 to see an even higher turnover might seem a tad optimistic. But that aside, there is a near consensus in the market that an increase in STT to garner the required resources is a for more efficient means than reintroducing LTCGT. Most market players and tax experts agreed to express their misgivings on the subject only off the record.
A fund manager said, “The reintroduction of LTCGT has not gone down very well with the investor fraternity. Increase in STT would have been understood by the markets. With this, a lot of compliance comes in for many foreign portfolio investors.” Nirmal Jain, founder, IIFL, was more forthright: “We should not forget that when STT was introduced, it was in place of lower taxes on capital gains. That is the problem with our Indian tax system. Instead of making it simpler, we make it complicated.” The head of a leading securities firm contended, “There would have been objections if they had increased STT too, as people would have talked about higher transaction cost hampering liquidity. It would have hurt the derivative traders because derivatives work on a thin margin.” A rough math shows that without disturbing the derivatives market, just by increasing the levy on delivery based trades—which are also the ones eligible for LTCGT—the government can easily mop up its desired sum, which brokerage Motilal Oswal estimates at about Rs 20,000 crore.
Tax experts, however, peg potential realisations even lower. To give a sense, the annual demat turnover on just National Stock Exchange was Rs 50.56 lakh crore in FY17. It wouldn’t take much to up the 0.1% STT at present on such trades to garner the sum. “The government is looking to collect Rs 20,000 crore with the reintroduction of LTCGT, which I don’t think will come if the environment in the market is such,” said a senior BSE broker on condition of anonymity. “If they wanted more tax revenue, they could have tinkered STT, and that would have been a sure shot,” he added.
A tax expert, speaking on the condition of anonymity, agrees, “The simplest and cost effective way of collecting revenue could have been tweaking the STT regime, rather than doing anything on long-term capital gains. The amount of time and effort to comply with this will not be commensurate with the revenue the government might get”. The other interesting facet that has come to light from the recent move is the big bridging of the gap between short-term capital gains tax (STCGT) and LTCGT, which is now down to just 5% from 15% earlier. This leaves little investment for long-term investment. Is this why the government has anticipated a higher STT in BEFY19? UR Bhat, MD, Dalton Capital Advisors, said, “People may probably not book long-term capital gain if it is not tax-free. What they could have done is increased the short-term capital gains tax. Short-term capital gain is made by people who are trading. There is no reason why they should be given special treatment.”
The other apprehension among marketmen is a flight of foreign investor business. “Singapore is planning to introduce stock futures. Trading on stock futures of Singapore will not pull any LTCG or STT. This will make several FIIs trade over there, and not in India,” explained Jain. However, the government’s incentives provided to investors trading on stock exchanges in the International Financial Services Centre (IFSC) at Gift City in Gujarat, might provide an option, but lead to flight of volumes from the present exchanges. Another avoidable consequence of the Rs 1 lakh limit norm could be an incentive for individual investors to again start buying and selling shares of family members, to avoid a payout so far as possible. This after a fair deal of consolidation of demat accounts has taken place over the years, will not be a positive outcome.