Hike in capital gains tax only a temporary concern, say MF players

Venkat Chalasani, Chief Executive, Association of Mutual Funds (AMFI) is of the view that the increase in exemption limit for LTCG tax is a welcome change.

The government’s decision to hike tax on both, long-term capital gains and short-term capital gains, took the mutual fund industry by surprise though industry participants are unanimous in saying that this is only a temporary concern and will not have any serious impact on the investors.

While presenting the Union Budget on July 24, Finance Minister Nirmala Sitharaman proposed increasing the tax on LTCG from 10 percent to 12.5 percent while increasing the STCG from 15 percent to 20 percent.

More importantly, the exemption limit for capital gains on certain financial assets has been increased to Rs 1.25 lakh per year, which, according to the government, will benefit lower and middle-income groups.

Venkat Chalasani, Chief Executive, Association of Mutual Funds (AMFI) is of the view that the increase in exemption limit for LTCG tax is a welcome change.

“While the changes in rates for Long Term Capital Gain (LTCG) and Short Term Capital Gain (STCG) were not anticipated, the markets will take them in their stride,” he said.

Incidentally, AMFI, in a pre-budget note, had suggested that the LTCG on listed equity shares or units of equity-oriented fund schemes, held for more than one year and up to three years be subjected to tax at the rate of 10 percent on capital gains exceeding Rs 2 lakh in a financial year.

Additionally, they had hoped for gains from such assets (if held more than three years) to be exempted from capital gains tax.

Post the announcement in an interaction with CNBC-TV18, TV Somanathan, Secretary, Finance defended this move, stating that the move was a positive and would benefit both government and taxpayers.

Short-term fears, long-term benefit

Trideep Bhattacharya, CIO-Equity, Edelweiss MF told Moneycontrol that the announcement of an increase in the long-term capital gains tax from 10 percent to 12.5 percent represents only a small incremental increase for investors.

For a two-year holding period, investors will see an impact of 1.25 percent (on the total returns), he says.

“Generally, the holding period for investors is between 3 to 5 years. If we consider a 5-year holding period, the impact would be around 2.5 percent, or 50 basis points per annum. This marginal decrease does not significantly affect the liquidity of the equity market, as investors typically seek returns that are much higher than this. The 50 basis points per annum is relatively minor and does not materially alter investment decisions,” explains Bhattacharya.

Another benefit, according to Bhattacharya, is the rationalisation of the tax rate across different asset classes, such as equities and real estate, to a uniform 12.5 percent. This eliminates previous arbitrage opportunities and could make equities a more attractive asset class, potentially leading to increased inflows from investors shifting funds from other assets.

"The consistent tax policy also removes uncertainty and overhang about future tax increases, which had been a concern in previous budget announcements," he says.

Meanwhile Mayukh Datta, CBO at ITI Mutual Fund, highlights the fact that while the changes have been announced for equity funds, debt funds have not seen any changes and continued to be taxed in the same way.

One aspect, he notes that is missing from the discussion, is hybrid schemes, particularly those with less than 65 percent in equities and more than 35 percent in debt where the long-term capital gains tax has decreased from 20 percent with indexation to 12.5 percent without indexation.

“Additionally, the holding period to qualify for long-term gains has been reduced from 36 months to 24 months for these assets. This change is significant as it applies to various asset classes, including property,” he says.

The increase in exemption limit for long-term capital gains, experts say, could benefit small investors and encourage them to invest in equities.

Vinit Sambre, Head of Equity at DSP Mutual Fund, told Moneycontrol that at the end of the day investors will likely still focus on high-yielding assets for long-term outperformance.

“With uniform taxation across asset classes, the key consideration will be the long-term returns generated by each asset class. From this perspective, the change is not expected to have a significant negative impact (for the mutual fund industry),” he said.

Datta concurs, adding that the increase in capital gains tax does not significantly alter investment decisions for most people, as taxes are generally not the primary factor influencing such decisions.

He adds that in India, capital gains tax is only applied when gains are realized, unlike in some other countries where taxes are applied to notional gains. Therefore, the impact of the increased tax is only felt upon exiting an investment.

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