Union Budget 2025: Should investors be worried about a possible hike in capital gains tax?

The finance minister had raised capital gains tax on equity investments in the last budget.

The hike in capital gains tax which came out as a pain point for investors in the last budget, having left many fearing it was the first step toward further increases. The government had raised the short-term capital gains tax on equity holdings held for less than one year from 15 percent to 20 percent. Similarly, the long-term capital gains tax on holdings sold after one year was increased from 10 percent to 12.5 percent.

Ashish Gupta, Chief Investment Officer at Axis Mutual Fund, warned that the hike might only be the beginning. "To my mind, this looks like a first step, as 12.5 percent is an unusual rate. I wouldn’t be surprised if it moves up to 15 percent by the next Budget," Gupta had remarked after Modi 3.0’s July Budget.

Right now however, most market experts currently do not anticipate another hike in capital gains tax, especially in such quick succession. According to Moneycontrol's latest markets poll, nearly 90 percent of respondents believe the finance minister will not raise capital gains tax in the upcoming Budget.

The Moneycontrol Market Poll reached out to market participants across categories – broking firms, mutual funds, AIF/PMS players and independent analysts – and received more than three dozen responses.

Despite this consensus, the possibility of a surprise hike cannot be completely ruled out. Such a move could disrupt the market, exacerbating existing concerns over sluggish earnings growth, economic slowdown, and expensive valuations. Higher taxes would make equities less attractive to investors, potentially prompting a shift toward longer-term investments in debt instruments or other tax-efficient options.

"While we don’t expect a further hike in capital gains tax, any such move will hurt the sentiment of all classes of investors. Any tax hike means the investor will be left with less profits," said Rahul Jain, President and Head of Nuvama Wealth.

"Any move aimed at hiking the capital gain tax will dampen the sentiments in the near term and may lead to a reduction in fund flows, be it institutional investors or retail investors who have been investing big time in mutual funds," Jain said.

On the other hand, long-term impact of higher capital gains tax are far reaching. To give a recap, market veteran Shankar Sharma recalled the imposition of long-term capital gains tax back in 2018, which was followed by a period of India’s underperformance relative to global markets.

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"In 2019, following the LTCG tax, India ranked as the 18th worst-performing market globally, with only 6-7 percent returns, compared to 25-35 percent gains in other major markets like Europe, the S&P, and Nasdaq," he said.

Foreign institutional investors (FIIs) are particularly disadvantaged by such tax increases, as reflected in the disparity between pre-tax and post-tax returns. Samir Arora, founder and fund manager of Helios Capital has highlighted that while Indian equities have performed well on a pre-tax basis, higher taxes could lead to a permanent reduction in post-tax returns, potentially deterring FII participation.

Meanwhile, Sonam Srivastava, fund manager at Wright Research also cautioned a more nuanced long term impact of higher capital gains tax. Srivastava is of the view that higher taxes on short-term gains could reduce speculative trading, potentially leading to more stable and sustainable market growth.

"However, there is also a risk of reduced participation from retail investors, which could impact market depth and liquidity," Srivastava said. A tax hike may also trigger reduced trading volumes, especially in the derivatives segment as investors reassess their strategies in light of higher transaction costs. "This may result in decreased market liquidity," she said.

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