Budget 2024 and the market: How badly could a hike in capital gains tax affect sentiment?

Market veterans said that any hike in capital gains tax could affect high-networth individuals in particular.

There are many worrying about an increase in the capital gains tax in the coming budget. Long-time observers believe any increase will prove a dampener in the short term, and may in fact not have the desired result of increasing government revenues. Instead, it might end up simply hurting investors and companies looking to raise money.

Currently, capital gains tax on equity holdings (either as shares or units of equity oriented mutual funds) sold before one year attracts a short-term capital gains tax (SCGT) of 15 percent while those sold after one year attracts a long-term capital gains tax (LTCG) of 10 percent on gains over Rs 1 lakh in one year.

"Of course a hike will affect market sentiment and it will affect it disproportionately. It will put the market in a bad mood for a while," said Dhirendra Kumar, CEO of Value Research.

Kumar had written in 2022 about how the Indian equity investor is a "little too obsessed" with capital gains tax. While he advises investors against worrying about it too much, he does consider capital gains tax as an unfair burden because the underlying company has already paid its taxes.

Also read: Should traders be worried about the securities transaction tax in Union Budget 2024?

It was in Budget 2018 that taxation on capital gains on the sale of equity and units of equity-oriented mutual funds was introduced. Suresh Swamy, partner at PwC India, said that if the market reaction to this move could be taken as an indication, "investors would have to brace themselves for a tough ride".

Swamy added that there are no indications yet that any increase may be announced.

Value Research's Kumar pointed out that the market reaction in 2018 could also be attributed to the poor corporate earnings in that period.

Rajesh Gandhi, partner at Deloitte India, said  that the impact of any hike may be felt more by high net-worth individuals (HNIs). Gandhi said, "Any hike in capital gains tax could create at least a temporary adverse impact both on market sentiment and tax leakage for investors considering that the markets have performed very well."

He added, "While the impact would be all across, it could be felt more by HNIs and other investors who trade significantly."

A hike may simply dissuade people from realising their gains and end up not serving the purpose of generating income for the government, pointed out Gouri Puri, partner at Shardul Amarchand Mangaldas.

She said, "A hike in capital gains tax could adversely impact the sentiment around savings and investment. People may be less inclined to realise gains, which in turn could offset the expected revenue gains from higher tax rates. This could impact both retail investors and Indian ventures that are looking for capital."

To boost sentiment

Will any announcement around capital gains tax help the market?

Veterans said that rationalisation of the tax structure to simplify it would definitely boost sentiment.

Harsh Roongta, a registered Investment Advisor and founder of Fee Only Investment Advisors, said that he does not know what change around capital gains tax will be announced but added that if any change was being planned, it should be to overhaul the structure to make it simpler.

"Long-term capital gains tax is a mess," he said, citing the many parameters involved, whether it is in the duration of holding or the type of asset to be considered while calculating the tax due.

Roongta said that he wrote the textbook for National Institute of Securities Markets (NISM) and that it took the team one whole day to work out the intricacies in the tax structure. They finally had to break it up into three tables to capture all the exceptions and make them intelligible.

Roongta said that he has no idea if there will be any change in the capital gains tax structure but said that it was something that has to be done, because all the tinkering with the structure has created a "smorgasbord that nobody can remember". He even extended an "open challenge" to anyone in the finance ministry to recall just from memory the intricacies of the taxation.

Roongta's opinion is shared by other veterans though expressed less vociferously.

Deloitte's Gandhi said, "There is a general expectation that capital gains tax rules should be simplified across different asset classes. This could be initiated in Budget 2024 with certain tweaks to the rules. Also, there is an expectation that taxation of derivatives should be moderated. There is also an expectation to provide clarity in taxation of Cat 3 (category 3 or more complex) AIFs (alternative investment funds)  especially long-only funds."

Also read: Sector Watch: AMCs seek parity between ULIPs, equity mutual funds from Budget 2024

Such a change would be driven by the "need for simplicity and ease of investing as well as providing relief to F&O (futures and options)  investors", he added.

Shardul Amarchand Mangaldas' Puri said that rationalisation of the capital gains tax regime has been a longstanding demand from the industry, which believes that the distortionary impact of having different rates across asset classes and investors adversely affects the development of Indian capital markets and promotes inequity.

Puri added, "The capital gains tax provisions are currently a maze and complex to understand."