Last time we discussed in detail the amendments made to the Budget proposals while passing them in the Parliament. However, the flood of emails that I have received on the subject makes it clear that even now certain valid doubts persist amongst investors.
Consequently, I have classified the queries under the following broad topics in an effort to address these concerns. Some tax planning measures arising from the changes made have also been discussed.
From when is the Securities Transaction Tax (STT) applicable?
This is one question worrying almost all investors. Yes, the bill has been passed and become an act. However, even today, the STT is not actually applicable. Chapter VII of the Act dealing with STT clearly states that it will be applicable only after an announcement to the effect in the official gazette.
And this announcement has not yet taken place. Reportedly, the stock exchanges are in the process of getting the modalities and logistics of applying the STT across various classes of investors and this will take some time. According to some media reports, the date is tentatively set for October 1.
The consequence of all this is that if you undertake any transaction in equity or equity mutual funds, etc., you will be subject to the old rates of taxation.
In other words, if you redeem units of an equity oriented fund tomorrow (i.e., before the announcement in the official gazette), you will not be liable to pay the STT.
Simultaneously, the long-term capital gains tax exemption (LTCG exemption) or the 10 per cent rate of short-term capital gains (STCG rate) will not be applicable. Which takes me to my next point.
STT, LTCG exemption, STCG rate go hand in hand
The best way to understand the changes is to view the three as mutually inclusive. In other words, STT always forms a partnership with the LTCG exemption or the STCG rate.
Stating it differently, if you haven't paid STT on any transaction, then automatically you are not eligible for any of the other two. They either are applicable together or not applicable at all.
Exemptions applicable to existing securities
However, that is not to say that your existing units or shares would not be eligible. The LTCG exemption or the STCG rate is applicable to sale of old purchases of eligible assets before the date of announcement provided the sale has taken place on or after the announcement.
It does not matter whether your existing equity/units have been bought fifteen years back, ten years back or even yesterday. As long as you sell the assets after the STT comes into force, you would be eligible for exemption.
Set-off of losses
This is yet another area where confusion prevails. This is because of the fact that if long-term gains are made tax-free, tax breaks cannot be availed of on eligible long-term losses. The same has to be foregone or set-off against LTCG of other assets where LTCG tax is payable. This point is discussed in more detail later on in the article.
STT not available as addition to cost of acquisition
Investors must note that the STT is a tax payable not a direct cost of purchase or sale. Therefore, the same would not be available as an additional cost to be reduced from the sale price to arrive at the capital gain.
However for security traders, the same is available as a setoff from that part of tax payable as is attributable to their income only from buying and selling securities.
This is blatantly unfair to investors. True, investors will not be paying any LTCG tax. However, what about the 10 per cent STCG tax? If traders are allowed a set-off from their tax payable, why the discrimination against investors? After all they too contribute to the exchequer's kitty.
A far simpler and more equitable way would have been to provide that where any additional tax is payable on securities transactions, the same can be set-off against the STT paid to the extent of the tax paid or the STT paid whichever is lower.
Some urgent tax planning
The situation as it is poised lends itself to some quick tax planning. However, since the window is open for a potentially short duration, investors should lose no time. Let's see what can be done in various situations.
As per the current law, a long-term loss can only be set-off against long-term gains. A short-term loss can be set-off against long as well as short-term gains.
First, if you are about to book profits (sell your investments) then it is better to wait for a month or so, to get the advantage of tax exemption. Remember, if you sell now (before the announcement in the official gazette), you would have to pay the applicable tax.
However, say you have already booked profit. Then if possible, sell your underperforming investments now, book the loss and setoff the same against the profit.
Even if you have not booked profit, but are carrying forward losses from the previous year or have already booked loss in the current year, then it could be a good idea to sell and earn capital gains and set-off the loss against the gains.
The by-product of this strategy is that you will be able to cash in on your gains now (instead of waiting for the new tax regime) without any tax consequence. Then you are free to re-enter the market and by that time the new tax system would protect your gains from tax.
Last but not least, there are several investors who have unfortunately lost the record of the cost of their purchases.
This generally happens during the demat process or because the shares are so old that it is almost impossible to locate any supporting evidence of the cost of acquisition. In such cases, hapless investors have no option but to treat the entire sale proceeds as capital gains and pay tax on the full amount.
However, now there is an obvious way out. All such investments (where no record of cost exists) may be sold free of tax once the STT comes into force. For a small fee of 0.075 per cent (the STT payable) the entire sale proceeds will be tax-free.
An anomaly
A seemingly inadvertent inconsistency seems to have arisen from the proposals. Earlier, set-off of long-term loss against short-term gains was not allowed as the rate of short-term gains was higher than that on long-term gains.
So to prevent investors from selecting short-term gains for the long-term set-off, this rule was introduced.
However, now on certain eligible assets, the short-term rate of 10 per cent is actually lower than taxable long-term rate of 20 per cent. Therefore, it is submitted that the department should introduce the necessary amendment to make such short-term gains eligible for set-off against long-term loss.