As long-term capital gains tax on equity will become a reality from April this year, here’s what you should do between now and March 31 to manage your equity portfolio.
Long-term capital gains (LTCG) tax is a reality now and we all must live with it. Before considering a tax-efficient response strategy to manage your equity portfolio, let us brush up the facts about LTCG tax. The LTCG arising out of the sale of equity and equity mutual funds, held for more than one year, is subject to 10% tax without benefit of indexation. Secondly, LTCG up to Rs 1 lakh in a financial year is exempted. It is applicable only on the sale of equity after March 31, 2018. For equity purchased before July 31, 2017, the acquisition cost is higher of the (a) actual acquisition price or (b) the highest price observed on January 31, 2018. LTCG accumulated till January 31, 2018, is exempted.
Between now and March 31, 2018
Now let us see what you should do between now and March 31, 2018, from tax minimisation perspective. You can sell your portfolio any time depending on your liquidity need and market view. But since the LTCG tax is applicable effective April 1, 2018, the temptation is to book LTCG before in FY18 and enjoy LTCG tax exemption. But is this a correct strategy?
Let us try to understand by using a stylised example.
An investor is holding the portfolio of two equity funds A and B. He invested Rs 5 lakh each of these funds before January 31, 2017. For ease of understanding, let us assume that (a) our investor will have Rs 1 lakh of LTCG from other equity investments in FY19 , and (b), he wants to hold onto his funds and will transact only to save tax. Both funds are now worth Rs 5.5 lakh each, and the total portfolio value is Rs 11 lakh. But both A and B were worth Rs 6 lakh each based on NAV of January 31, 2018. Selling any of your funds today, is a bad decision considering the fact that LTCG for the investments made before July 31, 2017, is calculated as explained earlier. In our case, both funds are worth less than their value as on January 31, 2018.
Thus, no LTCG made and no question of enjoying LTCG tax exemption, in fact, you will pay STT. So why not to continue holding your funds after March 31, 2018, without worrying about LTCG tax obligation. Now what happens if between now and March 31, 2018, Fund A gains but Fund B loses value? Suppose as on March 31, 2018, Fund A is worth Rs 6.9 lakh and Fund B is worth Rs 5.1 lakh. Of course, the total portfolio value is still Rs 12 lakh, same as it was on January 31, 2018. But now you must redeem Fund A on March 31, 2018, and buy it again on April 1, 20 to save tax.
Calculating the tax outgo
Why? Well, even if you decide to redeem your fund the very next day, on April 1, 2018, you have to pay tax of Rs 9000 (10% of Rs 6.9 lakh minus Rs 6 lakh). Well, you may argue that your total portfolio value remains the same Rs 12 lakh as it was on January 31, 2018, and so you don’t have to pay any tax. But here is the catch. While calculating LTCG, higher of purchase NAV or the NAV on January 31, 2018 is treated as an acquisition cost; to calculate and claim the long-term capital loss (LTCL), grandfathering is not allowed.
So if you decide to redeem your Fund B along with Fund A on April 1, 2018, you can’t claim LTCL on Fund B. In this case, the cost of purchase is the original acquisition cost of Rs 5 lakh and not Rs 6 lakh which was the value of Fund B based on NAV on January 31, 2018. You can claim set-off of LTCG against LTCL but your LTCL is on acquisition price and not on the NAV on January 31, 2018. Since Rs 5.1 lakh is greater than Rs 5 lakh of original acquisition cost, you can’t claim LTCL.
I have used a simple example of the two-fund portfolio to make my point; you may be holding the portfolio of several stocks, equity mutual funds, etc. Aggregating everything and looking at the portfolio value on January 31, 2018, and tracking it through to March 31, 2018, may lead to suboptimal decision making. Better watch every stock and equity fund move from hereon and make your decision closer to March 31, 2018, on a case-to-case basis.
By Mayank Joshipura
The writer is professor & chairperson (Finance), School of Business Management, NMIMS, Mumbai