As the government gears up to present the first Budget of its second term, there is an expectation that the Finance Minister will introduce tax amendments to boost the stock market. This is more so since any gain or loss from transfer of a financial asset has tax implications for an individual taxpayer and could substantially impact the choice of the investment portfolio.
In the Finance Act, 2018, changes were made under capital gains taxation regime wherein tax was levied on long-term capital gains (LTCG) exceeding INR 1 Lakh from the sale of listed equity shares and units of equity-oriented mutual funds, which were fully exempt previously. These changes were made effective from 1 February 2019 as capital gains up to January 31, 2018 were grandfathered (i.e. were kept exempt from tax). These amendments were applicable for foreign institutional investors (FIIs) as well. The intent of introducing this new regime of taxation of LTCG was to address the bias of diversion of investments in financial assets. It was also to curb the erosion in the tax base and prevent the use of tax arbitrage opportunities created on account of exemption of LTCG.
The new regime, that was introduced last year, has restrained participants, already reeling from the burden of the Securities Transaction Tax, from making long term investment in stock markets.
In this year’s Budget, the government could consider increasing the threshold limit of LTCG on sale of listed equity shares and units of equity-oriented mutual funds which is currently pegged at of INR 1 lakh per financial year. Enhancement of this exemption threshold will encourage tax payers to make investment in capital market, especially mutual funds which have seen strong growth in recent years.
Another important area to revisit relates to the amendment carried out by the Finance Act, 2018 which had restricted the scope of LTCG exemption under Section 54EC. Section 54EC provides for exemption on LTCG of up to INR 50 Lakhs, provided such LTCG is invested in the redeemable bonds of National Highways Authority of India (NHAI)/ Rural Electrification Corporation Limited (REC).
Previously, such exemption was available on LTCG arising from sale of any capital asset but via Finance Act, 2018, its scope has been curtailed only to the LTCG arising from the sale of land/ buildings or both. Thus, the LTCG arising from the sale of shares/ securities/ mutual funds had been kept out of its purview. This has greatly affected investors earning LTCG on sale of shares, especially listed shares and units of equity-oriented funds as they can no longer claim exemption under Section 10(38) when the LTCG exceeds INR 1 lakh. Hence, the government could consider rolling back the said amendment.
In addition to above, the government could also look at following changes in respect of capital gains taxation:
Reducing the holding period of debt funds – By bringing down the cut-off limit of the holding period of debt funds from three to one year. This will lead to tax relief for debt investors and align the holding period of debt funds with that of other capital market securities, to qualify for LTCG. The government may go for this change as the tax revenue loss will be significantly less compared to other possible measures such as removing LTCG on equities or removing STT.
Separate deduction for investment in ELSS – currently the deduction of INR 1.5 lakhs available under Section 80CCE - is generally exhausted by individual taxpayers by investing in debt instruments such as PPF, EPF or five-year fixed deposits etc. as provided under Section 80C. An individual taxpayer should have good exposure in equity-oriented mutual funds for good long term returns, consider inflation-adjusted return on other debt savings mentioned above. The deduction in respect of contribution towards Equity Linked Saving Scheme (ELSS) should be excluded from the overall limit of INR 1.5 Lakhs under Section 80CCE, and allowed as a separate option. This change will encourage retail investors to park a chunk of their savings in equity to earn better returns.
In summary, if the above suggestions are implemented, it would provide boost to the stock market as well as encourage individuals to plan a diversified portfolio that could include long term investments in financial assets.
Poorva Prakash is Senior Director, Tarun Garg is Manager, and Shubham Goel is Deputy Manager with Deloitte Haskins and Sells LLP