Deciphering LTCG tax on equity

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What is LTCG?

  • LTCG or long-term capital gains refer to the gains made on any class of asset held for a particular period of time. In case of equity shares, it refers to the gains made on stocks held for more than one year. In other words, if the shares are bought and held for more than a year before selling, then the gains, if any, on the said sale are referred to as long term capital gains or LTCG.

Why is LTCG tax in the news?

  • It is in the news as Finance Minister Arun Jaitley re-introduced LTCG tax on equity shares. Investors have to pay 10% LTCG tax on gains exceeding ₹one lakh on the sale of shares or equity mutual funds held for more than one year. Previously, short-term capital gains (STCG) tax of 15% was levied.
  • The Centre said if the gains exceeded ₹one lakh in a year, then 10% LTCG tax had to be paid without the benefit of indexation (adjusting the profit against inflation to compute the real taxable gains).

Was the tax levied on stock market trades earlier?

  • Such a tax existed until October 2004 when it was replaced by the securities transaction tax (STT) which was levied on all trades made on the stock exchanges.
  • STT is charged at 0.1% of the trade value in cash market trades. In the derivatives segment, 0.05% STT is charged on the options premium while it is pegged at 0.01% on futures. Incidentally, there was always a section of market participants that favoured LTCG tax over STT.
  • The issue of tax evasion through stock exchanges by paying a small STT component instead of LTCG had been raised regularly. Further, a study in 2016 stated that between 2005-06 and 2011-12, the Centre lost about ₹3.5 lakh crore by replacing LTCG tax with STT.

How will LTCG tax be computed?

  • Typically, when such a levy is introduced, it is structured in a manner so that prior investments get some kind of relief. In technical parlance, it is called the grandfathering benefit.
  • The government, while reintroducing the LTCG tax, said all gains made prior to January 31 would be grandfathered.
  • Here is how it works: for example, assume an entity bought shares in January 2017 at ₹100, which touched a high of ₹200 on January 31, 2018. Now, if he or she sells the shares at ₹300 in, say, May 2018, then his taxable gains would be ₹100. (₹300-₹200).

Will all investors be subject to LTCG tax?

  • All investors who trade on stock exchanges would be required to pay LTCG tax. Incidentally, the Centre has brought in LTCG tax while retaining STT as well. So, investors will have to pay both the taxes. However, foreign portfolio investors (FPIs), who invest in India from places like Mauritius and Singapore, would not be subject to LTCG tax, courtesy tax avoidance treaties.
  • This benefit, however, would be available only till the time the treaty benefit exists as the Centre is reworking all such so-called double tax avoidance agreements (DTAA).
  • For instance, the Singapore and Mauritius treaties also have a grandfathering clause plus a tax of only 5% on the computed gains. This, in effect, makes it more attractive for foreign investors to trade through the Mauritius or Singapore route.

How did the stock markets react to the introduction of the tax?

  • On Friday, a day after the Budget, benchmark equity indices — Sensex and Nifty — lost more than 2% each. The Sensex lost more than 900 points during intraday trading as it ended with its worst single-day fall in almost 15 months.
  • The introduction of LTCG tax can only increase the cost of trading stocks at a time when various market participants have been highlighting the ‘export of capital’ to other countries due to lower transaction costs in those nations. Incidentally, there are already reports that the government might look at the possibility of at least allowing the benefit of indexation while computing LTCG that would be a partial relief to investors.

Source:TH