Capital Gains Tax Tinkering May Spook Markets

'Expectations are high regarding the change in LTCG with respect to equity investments.'

Any changes to the existing capital gains tax structure -- especially the hike in rate of taxation on sale of stocks of listed companies -- can trigger a market correction, said analysts, who want Finance Minister Nirmala Sitharaman to maintain the status quo as regards this in the upcoming Budget on July 23.

"An increase in the tenure/holding period for classification of gains into long-term and short-term will not impact the market much. There might be a correction for a day or two as a knee-jerk reaction, but the markets will find their feet soon," said Nishit Master, portfolio manager, Axis Securities PMS.

"However, if the rate of taxation on sale of shares of listed entities is hiked, the markets can dip up to 3 to 5 per cent and the sentiment can remain subdued for a month or so," Master added.

Currently, investors pay 15 per cent short-term capital gains tax (STCG) in case the holding period of the listed stocks is less than a year.

On the other hand, if a seller makes a long-term capital gain of over Rs 1 lakh (where the holding period is over 12 months) on the sale of equity shares or equity-oriented units of a mutual fund, the gain made will attract a long-term capital gains (LTCG) tax of 10 per cent (plus applicable cess).

"In the Modi 3.0 Budget 2024, expectations are high regarding the change in LTCG with respect to equity investments," said Manikandan S, tax expert, ClearTax.

"The long-term capital gain tax was reintroduced in 2018, but one can expect changes in the same under this in the Budget later this month," added Manikandan.

Market pundits also expect some changes in the tax treatment of gains arising from trades in the futures and options (F&O) segment.

Market regulator Securities and Exchange Board of India has been cautioning against the rise in speculative activity in the F&O segment since the past few months now.

As per the Income Tax Act 1961, said Manikandan, income from F&O trading is classified as non-speculative business income.

This, experts believe, could now be classified as income from speculative activity and taxed at a higher rate.

"Such a reclassification can impact volumes in the F&O segment, which I think is good for the long-term health of the market," Master of Axis Securities PMS said.

G Chokkalingam, head of research and founder of Equinomics Research, too, expects some changes in the tax treatment for the F&O segment, which he believes will be in line with the recent 'words of caution' from market regulator Sebi and the government.

"There are chances that the government may reclassify gains from trading in the F&O segment as speculation and tax it at a higher rate of around 30 to 33 per cent," Chokkalingam said.

"Securities transaction tax could also be hiked. Such measures are likely to see a shift toward cash/delivery-based trades from the F&O segment. The markets can see a knee-jerk reaction to these proposals, but sanity should return soon," Chokkalingam said.

Capex spends

That said, the government, analysts believe, has ample headroom (approximately 0.3 per cent of gross domestic product) to continue spending on capex, as well as provide a consumption push, without disturbing fiscal consolidation.

"These (capex-driven) sectors -- infrastructure, capital goods, and defence -- are clearly in overbought territory. Favouring defensive names, especially those that benefit from higher government spending to spur private consumption," said said Jitendra Gohil, chief investment strategist at Kotak Alternate Asset Managers.

"We prefer rural-focused NBFCs, large-cap private banks, travel and tourism, and restaurant-related businesses, while maintaining our preference for pharmaceutical companies," Gohil added.

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Feature Presentation: Aslam Hunani/Rediff.com