When demonetisation was announced, the government’s political hardsell was that the rich were not being spared, that they too would have to stand in queues and come clean on their income. On Thursday, unveiling the Union Budget, Finance Minister Arun Jaitley reinforced this political message when he announced taxation on long-term capital gains from the stock market. And suggested this as part of a strategy to route business surpluses to manufacturing and real economy sectors, away from financial assets.
Announcing the proposal to impose long-term capital gains tax of 10 per cent on gains exceeding Rs 1 lakh arising from sale of listed equity shares or units of equity-oriented mutual funds, Jaitley also proposed a 10 per cent tax on dividend income distributed by equity-oriented mutual funds.
While declaring that all gains up to January 31, 2018 will be grandfathered and not attract tax, the move, Jaitley said, will lead to a marginal revenue gain of Rs 20,000 crore in the first year for the government. But the announcements had an immediate impact on the market which fell by 464 points from the Wednesday closing before retracting.
Jaitley said that with the equity market turning buoyant, the total amount of exempted capital gains from listed shares and units stands around Rs 367,000 crore as per returns filed for assessment year 2017-18.
Stating that a major part of this gain has been accrued to corporates and LLPs, he said, “This has also created a bias against manufacturing, leading to more business surpluses being invested in financial assets. The return on investment in equity is already quite attractive even without tax exemption. There is, therefore, a strong case for bringing long-term capital gains from listed equities in the tax net… I propose to tax such long-term capital gains exceeding Rs 1 lakh at the rate of 10 per cent without allowing the benefit of any indexation.”
While the Finance Minister said that big gains were made by corporates and LLPs, this decision will impact even the small retail investor. For example, even an individual investing Rs 2,000 every month for ten years in mutual funds through systematic investment plan may have to pay LTCG tax as his/her gains may well exceed Rs 1 lakh.
Market experts said the move may disrupt the recent phenomenon of retail investors from small towns entering the equity markets through mutual funds. Data from Association of Mutual Funds in India shows that the net inflow into equity schemes of mutual funds between April 1, 2015 and November 30, 2017 amounted to Rs 2.37 lakh crore. While retail inflow into equities have grown, that from smaller towns has grown at a faster rate.
Data shows that over the last four years, while mutual funds have witnessed their assets-under-management (AUM) nearly treble, the share of the top 15 cities in the entire AUM came down from 87.8 per cent in September 2011 to 84.1 per cent in September 2017. The share of cities beyond the top 15 has risen from 12.3 per cent of the total industry AUM to 15.6 per cent in the corresponding period.
“Rise in markets along with no LTCG helped the industry reach out to investors and attract investments from them. Now, the unique selling proposition (USP) has gone and a 10 per cent tax on equity gains exceeding Rs 1 lakh may disrupt such participation,” said the CEO of a mutual fund who did not wish to be named.
While introducing a 10 per cent tax on dividend distributed by equity-oriented mutual funds, Jaitley said, “This will provide a level-playing field across growth-oriented funds and dividend-distributing funds. In view of grandfathering, this change in capital gain tax will bring a marginal revenue gain of about Rs 20,000 crore in the first year. The revenues in subsequent years may be more.”