Will hike in capital-gains tax in Budget 2024 spook markets?

Tax experts said that what will help boost market sentiment would be simplifying the tax stucture.

The markets could react badly if there is any increase in capital gains tax, according to market insiders. There has been worries that the Union Budget may deliver a nasty surprise by raising the tax, and veterans believe that if this does happen, the current buoyancy would be dampened.

In conversations with Moneycontrol, market insiders said that any such hike may not even serve the purpose of increasing government revenues. Instead, it might end up simply hurting investors and companies looking to raise money.

Dhirendra Kumar, CEO of Value Research said that it will definitely put the markets in a "bad mood" for a while. Kumar had written in 2022 about how the Indian equity investor is a "little too obsessed" with capital gains tax.

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Capital gains tax was introduced in Budget 2018. Currently, 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.

Suresh Swamy, partner at PwC India, said that if the market reaction to the 2018 taxation could be taken as an indication, "investors would have to brace themselves for a tough ride".

Some experts such as Rajesh Gandhi, partner at Deloitte India, opined  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."

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There could be an unintended consequences from such a hike, according to Gouri Puri, partner at Shardul Amarchand Mangaldas. It may simply dissuade people from realising their gains and end up not serving the purpose of generating income for the government.

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."

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.

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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.

Roongta said that he has no idea if there will be any change in the capital gains tax structure but said that simplifying the structure was something that has to be done, because all the tinkering with the structure has created a "smorgasbord that nobody can remember".

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."

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.