In the Union Budget 2024, FM Sitharaman announced that the long-term capital gains (LTCG) tax rate on all financial and non-financial assets will rise from 10 per cent to 12.5 per cent
In a blow to investors, Finance Minister Nirmala Sitharaman announced significant modifications to the capital gains tax and securities transactions tax (STT). Sitharaman announced that the long-term capital gains (LTCG) tax rate on all financial and non-financial assets will rise from 10 per cent to 12.5 per cent, eliminating the previous tiered structure. However, the indexation benefit, which allowed taxpayers to adjust the purchase price of an asset for inflation, has been removed.
In addition, the holding period for determining whether a capital gain is short-term or long-term has been revised. Listed securities will now be considered long-term after 12 months, while other assets require a holding period of 24 months.
Short-term capital gains (STCG) tax rates on listed equities have been increased from 15 per cent to 20 per cent, while that on all other financial assets and non-financial assets shall continue to attract the applicable tax rate. The deduction limit for long-term capital gains on equity-related investments has been raised from Rs 1 lakh to Rs 1.25 lakh, the removal of indexation is expected to offset this benefit for many taxpayers.
Profits or gains earned from the transfer of a capital asset are called “capital gains” and are charged to tax under the heading “capital gains”.
“It is proposed to increase the rates of STT on sale of an option in securities from 0.0625 per cent to 0.1 per cent of the option premium. On sale of a futures in securities from 0.0125 per cent to 0.02 per cent of the price which such futures are traded,” the FM said.
History of the Capital Gains Tax
During the Union Budget of 1956-57, then finance minister TT Krishnamachari introduced a capital gains tax regime where capital gains up to Rs 15,000 were exempt from taxation. Individuals with gains of more than Rs 10 lakh taxed at 31.3 per cent.
In 1992, under the UPA government, then finance minister Manmohan Singh introduced indexation benefits for capital gains and a special tax rate of 20 per cent for LTCG. Since then, for LTCG, the cost of acquisition and the cost of improvement of assets are linked to a cost inflation index that is notified by the government every year. Indexation refers to the process through which the cost of inflation is adjusted against the inflationary rise in the value of an asset.
In 1997, then finance minister P Chidambaram exempted dividend tax for the shareholders. However, he continued the 20 per cent tax for LTCG with indexation.
Abolition of Long-term Capital Gains Tax
In 2002, the Vijay Kelkar-led task force on direct taxes recommended to not levy the LTCG tax. In 2003-04, the then finance minister, Jaswant Singh, removed such a tax in a limited way, with the intention of reviewing the change the following year. However, during his tenure, proposals for a 20 per cent tax with indexation benefit or a 10 per cent tax without indexation were continued, while short-term capital gains were taxed as per the slab rate.
In 2004, then Finance Minister P Chidambaram eliminated the long-term capital gains (LTCG) tax on securities transactions entirely and instead proposed a minor tax on transactions involving securities on stock exchanges. Additionally, he introduced a 10 per cent tax on short-term capital gains, which was later raised to 15 per cent in the 2008 Budget.
The stock markets reacted positively to this development as within a month after the abolition of the LTCG tax, the Sensex surged nearly 8 per cent or 375 points to 5,170 points on July 30, 2004.
After 14 years of absence, in the 2018-19 budget, former Finance Minister Arun Jaitley proposed to reintroduce a 10 per cent long-term capital gains (LTCG) tax on equities exceeding Rs 1 lakh. The government aimed to generate Rs 20,000 in revenue from this measure. Additionally, he introduced a 10 per cent tax on dividends exceeding Rs 10 lakh per annum.
Both the benchmark indices, Sensex and Nifty50, fell sharply in the aftermath of the budget. Within a month after the reintroduction of the LTCG tax, the investors showed their disappointment as the markets fell nearly 1,800 points. In February 2018, the BSE Sensex fell 5 per cent from 35,965.02 points to 34,184.04 points.
In the 2020-21 Budget, Finance Minister Nirmala Sitharaman did away with the dividend distribution tax, shifting the tax liability for dividends directly to shareholders.
What do the Market Experts Suggest?
The benchmark equity indices witnessed a sharp plunge as these tax hikes were announced, but the initial negative sentiment is expected to subside in a few days.
According to market analysts, while the increase in capital gains tax might affect the markets in the short term, these changes encourage a more stable and mature investment environment.
Sarvjeet Singh Virk, co-founder & MD of Shoonya by Finvasia says the budget aims to balance investor benefits and long-term market stability. “The rationalization of the capital gains tax regime promises a simpler and more navigable landscape for investors, promoting greater participation. The increased exemption limit for long-term capital gains on listed securities is a boon for smaller players, encouraging them to invest and contribute to market growth,” said Virk.
“While adjustments to STCG and STT might require adaptation, these changes can potentially encourage longer-term investment strategies, contributing to a more stable and mature market ecosystem,” he added.
On the budget day, after Sitharaman proposed to hike the capital gains tax, the Sensex dipped below 80,000 level to a low of 79,224 and was down 1,542 points from the day’s high of 80,766. The NSE Nifty 50 index plunged to a low of 24,074 in intra-day deals. On July 25, 2024, the Sensex was hovering around Rs 79,737 points.
Rahul Singh, CIO-Equities, Tata Asset Management says the budget has surprised negatively on capital gains. “We expect the equity markets to become more balanced as the growth in cyclical sectors (defense, manufacturing, capital goods, power) that have done well over the last 12-24 months get supplemented by the potential recovery in consumption as a result of the budget provisions,” Singh said.
“Higher capital gains could also result in market valuations consolidating at current levels with a rotation towards a more balanced sectoral performance. Given Budget’s par allocation to various sectors, thematic movements could subside leading to a bottom-up stock selection becoming more important,” Singh added.
Rupen Rajguru, Head of Equity Investments and Strategy at Julius Baer India says, the budget, at a margin, has been a bit disappointing from the capital markets perspective.
“The stock market will not shift its focus on Q1FY25 earnings and global cues. The earnings season so far has been in line, with some green shoots visible in the IT and consumption sector, although some sectors such as Financials are seeing some strain,” said Rajguru.
The recent changes to capital gains tax rates and STT reflect the government’s efforts to balance revenue generation by encouraging a stable investment market. While short-term market reactions have been volatile, these measures are expected to encourage longer-term and stable investments.