SENSEX and Nifty are trading at their lifetime highs. With booming capital Markets of India, rising long term Equity Shares and Equity Mutual Funds trading catching attention of the government. There might be a long term capital gain tax rate amendment in union budget 2018.

Long term Capital Gain Tax on Equity Trades

Long term capital gain tax is levied at a zero rate if any investor trades in STT paid equity shares or equity oriented mutual funds with minimum holding period of 12 months.

Increase in Equity Mutual Funds Investments

Flow of Investment in the Equity mutual funds stood close to Rs. 1.3 lakh crore in the year 2017. Major reasons for this massive inflow was

Tax Benefits: Equity Mutual funds attract long term capital gain tax rate of zero percent as compared to other investment options.

Better Returns: Decreasing deposit rates and low returns in gold, real estate forced investors to move to alternative options which are less riskier than individual equity trading.

Tax Revenue for the Government

The asset base of Equity Mutual Funds increased to Rs. 7.7 lakh crore as compared to Rs. 4.7 lakh crore in 2016. SIPs and equity mutual funds both are resulting in good gains for investors. On an average, top equity mutual funds yielded more than 20% annualized return to its investors. Some Equity shares rose by more than 100% this year. All this was backed by strong equity market forces as Nifty and SENSEX rose by more than 25% in the year 2017.

With increasing demand of reduction in rates under GST and overall fiscal deficit, government has to find out quick revenue sources to compensate. Tax on Long term capital gains can be a good source of revenue looking at the increasing investment and returns in the equity market.

Government options for Union Budget 2018

Securities transaction tax (STT) is already in place to have a taxation point in capital markets irrespective of gains/losses. Tax authorities are of the view that STT is only a tracker for securities market transactions and not a revenue objective tax.

Narendra Modi had already given indications that securities market shall contribute in nation building which either means to have increased STT or Long term capital gain tax rate.

Those who profit from financial markets must make a fair contribution to nation-building through taxes: PM @narendramodi — PMO India (@PMOIndia) December 24, 2016

The finance minister may think of below options:

Increase in holding period limit for LTCG

This is the easiest mode for government with less impact on sentiments. For Equity mutual funds holding period may be increased to 36 months. Currently, section 80C of the Income Tax Act also has a lock in period of 36 months for equity oriented mutual funds investments.

LTCG Exemption Limit

FM may go for capping the exemption on long term capital gains to a certain amount. For example: if a limit of 2 lakhs is prescribed, any individual earning LTCG of more than Rs. 2 lakhs on equity shall not be exempted and either be taxed at a fixed percentage or the gain gets included in the taxable income of the assessee.

LTCG Rate Change

Arun Jaitely also has the option of a small fixed rate on long term capital gains earned on equity trades. This rate can be leveled with the other LTCG items or it may vary from 5-15%. This will be an harsh option from the investor sentiment perspective.

Increase in STT

Another less favourable option is to increase the STT collected on every transaction, a fractional increase might result in good revenues considering the trading volumes. This will be impartial for those who incur loss on any transaction. These days, brokerage firms are trying to bring cost of transactions down to attract more investors, such a move is not good for the overall trading volume of the market

With Lok sabha elections coming in 2019, this is the last full year budget for Modi government therefore, there are high expectations of a populist budget. Modi and Jaitely may not want to disturb the investor sentiment looking at the stock market mood being in favour of the Modi led BJP government coming back in 2019. Increase in holding period will be an easy option. If not for equity shares, this can be implemented for Equity Mutual Fund trades.