Direct Taxes Code-Its Impact on Long-Term
Capital Gains on Shares and Mutual Funds
Ms Roshni Nair is a young and smart lady working for a multi-national company in their swanky office in Gurgaon drawing a lucrative salary. She is well-educated and financially savvy and invests her surplus in equity shares and equity mutual funds in addition to insurance, real estate and fixed deposits. She has started her equity investments during the stock market hey days of 2003-2004 and continues to invest regularly even now. Even though she churns her portfolio and books profits regularly on her portfolio of shares and mutual funds depending on the market conditions and her views; over a period of time she has amassed a long-term capital gain of around Rs 5 lakh on her equity portfolio comprising blue chip stocks, mid-cap stocks and equity mutual funds.
Now-a-days, she is a bit concerned about her long-term capital gains as she has read reports that she has to pay long-term capital gains tax on stocks and mutual funds with effect from April 1, 2011. This is as per the new Direct Taxes Code, or DTC, placed, for discussion, in the public domain by Government of India a few months back. To get a better view of the tax issues involved, she sets up a discussion with her tax consultant & the conversation follows:
ROSHNI: “GOOD MORNING, MR SHANBAGH?”
Shanbagh: “Morning, Roshni. I’m fine…thank you.”
“I WANT TO DISCUSS WITH YOU THE IMPACT OF NEW DTC ON MY LONG-TERM CAPITAL GAINS ON EQUITY SHARES AND EQUITY MUTUAL FUNDS.”
“Okay, the new DTC proposes to make some sweeping changes with regard to LTCG and STCG.”
“WHAT ARE THEY?”
“For tax treatment purposes, it proposes to abolish the distinction between long-term capital gains tax and short-term capital gains tax pertaining to capital gains on shares and mutual funds.”
“WHAT DOES THAT MEAN FOR MY INVESTMENTS?”
“Let me give you an example. As of now, you’re paying a short-term capital gains tax of 15 per cent, excluding education cess of three per cent, on your STCG and the tax on LTCG is nil for listed equity shares as well as equity mutual funds.”
“WHAT IS THE DIFFERENCE BETWEEN LTCG AND STCG.”
“As far as shares/mutual funds are concerned, LTCG arises when you hold them for a period of more than one year after the date of acquisition. If you hold them for less than a year, then it will be considered as short-term capital gain or loss as the case may be.”
“COULD YOU PLEASE EXPLAIN THE IMPLICATION?”
“Yes, let me cite a practical example. From your records, I find that you bought 1,000 shares of Blue Star in September 2003 for a total consideration of Rs 20,000 and sold them for Rs 340,000 in November 2009. Here, your capital gain is Rs 320,000 (340,000-20,000). As the shares were held for a period of more than one year, the entire Rs 320,000 is treated as LTCG and under the existing Income Tax Act, you need not pay any tax on this LTCG.”
“WHAT ABOUT TAX TREATMENT OF SHORT-TERM CAPITAL GAINS UNDER EXISTING TAX LAWS?”
“I’m coming to that. Again from your records, you bought 50 shares of Jet Airways for a total cost of Rs 13,500 in September 2009 & sold the entire stock for Rs 27,500 in the 1st week of Dec. 2009 making a profit of Rs 14,000. As the shares were held for less than one year, this Rs 14,000 is considered as short-term capital gains and you have to pay a short-capital gains tax of Rs 2,100 (15 per cent of Rs 14,000).”
“AND WHAT ABOUT THE NEW TAX PROPOSALS?”
“As per the draft code called Direct Taxes Code 2009, the definition of LTCG and STCG remains the same for shares and mutual funds. The only difference between the existing and proposed system is in tax treatment of them. Under DTC, there is no difference between STCG and LTCG. Both will be clubbed under your taxable income and you’ve to pay tax according to your individual tax slab.”
“PLEASE GIVE ME AN EXAMPLE.”
“In the above example cited, you do not incur any tax liability on LTCG under the existing laws. Under the proposed system, you’d have to add the entire Rs 320,000 LTCG made in selling Blue Star shares to your taxable income and pay tax according to your tax slab.”
“(COMPLETELY TAKEN ABACK!) YOU MEAN I’D HAVE TO PAY TAX FOR THE ENTIRE Rs. 320,000?”
“Yes, Roshni, if the Government implements the DTC as given in the draft DTC Bill, you’ve to club the entire LTCG with your taxable income. This addition would push up your tax slab to 30 per cent, excluding education cess. On this additional income, you’d have to pay a total tax of Rs 96,000 (30 per cent of Rs 320,000) in addition to tax on your annual salary.”
“GOSH, THAT IS TOO MUCH, NAH?”
“It can’t be helped. We need to follow tax rules. However, under the proposed DTC, you could avail indexation benefit and the tax incidence on LTCG is likely to come down if you utilize this indexation benefit. Under the existing system, indexation base date is April 1, 1981 and it is proposed to be changed to April 1, 2000. However, one saving grace here is Securities Transaction Tax (STT) charged now on all share transactions will be abolished completely under the DTC.”
“WHAT ABOUT THE TAX TREATMENT OF STCG?”
“As has been discussed, the DTC does not distinguish LTCG and STCG as far as tax treatment is concerned. In the above example, you made a STCG of Rs 14,000 on sale of Jet Airways shares. The entire Rs 14,000 will be clubbed with your taxable income and you’ve to pay tax according to your tax slab under DTC.”
“WHICH MEANS UNDER THE DTC, I’D HAVE TO PAY A TOTAL TAX OF AROUND 1.5 LAKH ON MY ACCUMULATED Rs. 5 LAKH OF LONG-TERM CAPITAL GAINS ON SHARES/MFs?”
“That’s right provided there’re no changes in the proposed DTC.”
“IN SUCH A CASE, SHALL I SELL ALL MY SHARES AND BOOK PROFITS IN ORDER TO SAVE ON EXTRA AND UNNECESSARY TAX?”
“It depends on several factors with regard to your ability to time the markets. But, there’re no easy answers, Roshni.”
Note: In this example; brokerage, STT, education cess, service tax are ignored for simplicity.
Now, you’ve read the conversation, do you think that investors should take out their entire long-term profit?
Market veteran and broker, Ramesh Damani opines that there would be a huge sell-off in the Indian stock markets if the new DTC is implemented in the draft form as stated now. However, timing the markets is fraught with danger. Mr. Ramesh Damani himself has learnt it the hard way in the last two years. Let’s imagine a scenario. Consider you are sitting on a long-term profit of around Rs 25 lakh and sold your entire holdings in 20 potential stocks before the implementation of DTC. This you’d done with a view to picking up the stocks at lower prices after April 1, 2011, the effective date for DTC.
Can we expect all the entire 20 stocks would be quoting below your selling price and you would be able to pick all the 20 stocks at lesser prices? It’s hard to imagine that you’d be able to be successful in all the 20 stocks.
However, this policy flip-flop from the authorities, who are supposed to promote some stable and long-term tax policies, will cost the investors very heavily in terms of achieving their long-term goals. This seems to be a case of Government encouraging investors to hold shares for short-term (PURE GAMBLING?) faster churning, instead of steady and long-term investments. The proposed DTC is also a big negative for the so-called long-term investors in equity shares and equity mutual funds. What a tectonic shift? All these years right from Yashwant Sinha to P Chidambaram, investors were actively encouraged to invest for long-term purposes in order to deepen and widen capital markets. Despite so many good developments in Indian capital markets in the last 15 years, the total savings in equities and mutual funds are at an abysmally low level of three to four per cent nationwide. With a view to promoting capital markets, the Government has been prodding organizations, like, EPFO and pension funds to invest a portion of their funds in capital markets. But now, the same authorities are giving a different spin under the proposed Direct Taxes Code.
HOW TO TWEAK YOUR INVESTMENTS GOING FORWARD IN THE LIGHT OF THE DTC WEF APRIL 1, 2011?
Timing the market is difficult and as such, it’s not practically possible to sell the equity shares now and acquire them after April 1, 2011. Then, what is the alternative? Shall the long-term investors hold on to their shares where there is enormous long-term capital gain? Or, shall they start offloading their shares before the deadline for the introduction of new Direct Taxes Code or DTC? Obviously, there’re no easy answers.
Each individual has to take their own decision depending on their own comfort levels. Investors, like, Warren Buffett, would not bother about such tax considerations and would not sell their shares for the fear of paying some tax on their capital gains. But, how many Indian investors’ pockets are as deep as that of Buffett? When everybody is selling in the market, can you remain steadfast and hold your fort in times of turbulence? Only time will tell. Till that time, one would love to make some wild guess that Government would not be able to muster enough courage to implement the new Direct Taxes Code in its present draft form.
Investors need to be aware of these provisions; otherwise, they will be completely spooked and confused when they are introduced ultimately in 2011. Knowledge of policy developments is vital in stock markets and other financial markets. If investors ignore these aspects, important rules and regulations, they will be ignoring them at their own peril.
Author’s Disclaimer: The views of the author are personal. The above shall not be construed as tax or investment advice, though due care has been taken before writing the above. Having said that, Investors or readers must consult their certified tax consultant before interpreting or considering the views expressed by the author.
No comments:
Post a Comment