How the LTCG move has effectively capped this rally

The Sensex plunged over 200 points on Thursday as the Finance Minister read out the provision on bringing back the long-term capital gains tax on equity shares and equity-oriented mutual funds in the Budget session.

But stocks were soon on their feet. The arguments put forth were, “this was expected anyway and is already factored in to stock prices,” “the grandfathering clause helps protect the profits so far,” “tomorrow is another day,” and so on.

But it’s obvious that the reality is sinking in to market participants the, the day after. It’s true that the Finance Minister has been quite considerate to investors and traders who have made good profits in the ongoing bull-run by not taxing profits made until January 31, 2018, if the shares or mutual funds are sold 12 months after purchase.

These rules come into force from April 1, 2019 and will apply to the assessment year 2019-20 and subsequent assessment years. So sale of shares held for more than one year, executed after April 1, 2018 will be taxed at 10 per cent.

The FM is, in other words, giving investors a one-time chance, to lock in to their profits now, and escape LTCG on profits made so far.

What does this mean?

Stocks have been racing higher over the past 12 months on poor fundamentals, taking valuations to crazy levels. A small push can cause a steep sell-off of at least 10 to 20 per cent. In this scenario, many investors might want to book their long-term gains, ahead of April 1, when these rules come into force, to avoid paying 10 per cent tax.

Even if stock prices rally higher from these levels, investors will sell, to avoid tax on the profit made from February 1 to end of March. So effectively, Jaitley has put a cap on this rally, at least for the next few months.

The Rs 1 lakh limit for taxing LTCG is not likely to help most investors as their portfolio values have swelled with the market rally.

FPIs too caught

Under existing provisions, where the total income of a Foreign Institutional Investor (FII) includes income by way of long-term capital gains arising from the transfer of certain securities, such capital gains is chargeable to tax at the rate of ten per cent. But long-term capital gains arising from transfer of equity or equity-oriented fund or a unit of business trusts was so far exempt from income-tax.

But the Budget has stated that as in the case of domestic investors, the FIIs will also be liable to tax on such long-term capital gains only in respect of amount of such gains exceeding one lakh rupees.

This is unlikely to go down well with FIIs.

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