How Long Term Capita Gains Tax Impacts Your Investments?

Union Budget 2018 was presented before the Parliament on 1st February 2018 by Union Finance Minister, Sh. Arun Jaitley. Amongst other things, one significant change that was proposed to be reintroduced was the Long Term Capital Gains (LTCG) Tax. This has left the investor fraternity worried as the gains so exempt till date may be now taxed at 10% from 1^st April 2018.

The Long-term capital gains were given tax exemption by P. Chidambaram while presenting the Union Budget for the year 2004-05 and such an exemption continued till the year 2017-18 wherein long-term capital gains from the sale of equity shares and equity-oriented mutual funds were exempt from tax under Section 10(38) of the Income Tax Act. However, w.e.f. 1^st April 2018, an additional tax has been proposed on such gains as per below framework:

What is the New LTCG Tax Rate?

1. LTCG tax rate – An additional tax at the rate of 10% (plus applicable surcharge and cess) shall be applicable on such gains.
2. Basic Exemption Limit for such gains – To protect the interest of investors with small gains, such long-term capital gains up to 1 lakh a year will continue to stay exempt and the additional tax shall be payable only on such gains exceeding Rs. 1 lakh.
3. No indexation benefit – While indexation benefit is allowed for most of the long-term capital gains, no indexation benefit shall be provided for such gains considering the special concessional rate of only 10% and basic exemption limit for such gains.
4. Grandfathering of existing gains – To avoid any perception of retrospective taxation of existing gains in the equity-related securities, LTCG tax has been introduced in a non-disruptive manner and hence, all the existing gains up to 31st January 2018 will be grandfathered. This means that the existing gains will continue to stay out of the tax net. 

ELSS and LTCG Tax

For the taxpayers who are willing to take some risk instead of fixed investments, Equity Linked Savings Schemes (ELSS) has been a preferred tax saving instrument. Since ELSS was a specified category of equity oriented mutual funds eligible for tax deduction, the LTCG tax has certainly affected the way investors used to consider them. Till the financial year 2017-18, ELSS was being seen as an investment instrument with Exempt-Exempt-Exempt status wherein the principal investment was tax exempted, the income accrual was exempted and even the maturity was also exempt from tax.

However, with the introduction of LTCG tax, investors may have to cough up tax @ 10% on the gains earned by them at the time of redemption of such investment. ELSS funds have given much better gains than the traditional investment avenues and it may be reasonable to expect similar outperformance as compared to the traditional investment avenues in the times to come as well. Thus, it may not be a wise decision to consider switching to other tax saving instruments just because the gains from ELSS funds will now be taxed.

Impact of LTCG Tax in choosing the type of Investment

While 0% tax is certainly better, 10% tax now must not deter you from investing in equity shares and equity oriented mutual funds. Here is how equity markets have resulted in much larger wealth creation opportunity than the traditional investment avenues and also, how LTCG tax may not impact the investing strategy too much:

Inspite of a major downfall in the markets in the year 208, equity markets would have allowed you to earn approx. twice the returns you would have made through traditional investment avenues. While paying tax is always painful, don’t let the fear of 10% LTCG tax deter you from investing in equities and equity mutual funds.