Moneycontrol Pro Panorama | If all debt income is short term, what about equity? 

The government’s view on financial assets appears to be different compared to physical assets.

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Amendments to the Union Budget are relatively a dull affair. Some tweaks to take care of drafting errors, a few sops and occasionally a rollback of a controversial measure is what we are accustomed to seeing. However, the amendments moved to Budget 2023 or more accurately to the Finance Bill, 2023 are significant in scope and impact.

The most prominent one is an amendment to how mutual funds are taxed, which will ensure that debt funds—more specifically, any fund with domestic equity contributing to less than 35 percent—will attract short term capital gains tax only. That is, if you are in the highest tax slab of 30 percent plus cess/surcharge, then that’s what you will pay on the gains. Currently, you pay 20 percent after indexation, but the indexation benefit is also gone now.

The popular view is that the government wants to tax debt schemes and fixed deposits at the same rate. That logic implies that, by removing the tax arbitrage, investors can still invest in debt funds but for higher returns by taking more risk and deferred returns by staying invested longer. But the amendment is short-sighted, argues Lisa Barbora in this piece, as it brings in non-debt MF schemes such as gold and international funds also within its ambit. And it does not address the multiplicity of capital gains regimes and rates that still exist, in real estate for example.

The mutual funds industry will be hit hard by these changes and that does not bode well for AMC stocks, writes Neha Dave in her analysis of these developments. But banks will be big beneficiaries as they have been hungry for more deposits to feed growing credit demand and the boost to deposit growth should see banks stocks benefit.

While a level playing field is one aspect, another could be the government’s desire to raise tax revenues too. For instance, a taxpayer-friendly measure to level the playing field could have been to give fixed deposits the same benefit as debt funds. But that would hit revenue hard.

The budget’s direct tax proposals itself had implied tax foregone of Rs 38,000 crore, according to the finance minister’s speech. And, the current amendments include one that gives marginal relief to taxpayers earning slightly higher than Rs 7 lakh, and who avail the new tax regime. That will mean more revenue lost. What’s more, the tax incentives availed by individuals is swelling every year, with the rebate for lower income earners contributing significantly. Today’s Chart of the Day has the details of why the government may want to raise more revenue.

The big mystery is on why such a momentous change was introduced quietly in the amendments. Was it a last-minute thought? Did the government want to avoid the hectic lobbying that would have tried to roll back this change if it was introduced it in the budget? This way, the decision became law in a jiffy and changing it will not be easy. Or have recent developments in the world, banking crises and growing threat of a recession, made the government worried about revenue growth in the coming year? The amendment will increase its revenue but by how much is not known.

While we may not know the real answers, the question is what comes next. While we don’t really want to play doomsday here, it’s a bit difficult to ignore the clear direction that we are moving towards. The government’s view on financial assets appears to be different compared to its view on physical assets. Capital gains don’t accrue from any effort, is how a former finance secretary described it. Shifting capital gains on debt to short term fits with that view.

This budget year too had seen reports of changes being considered to the long term capital gains regime on equities although nothing came of it. If we are to accept that holding debt for three or more years does not qualify it for long term capital gains, then why should equity get a special treatment is a question that could gain currency. After all, LTCG on equity shares was reintroduced in Budget 2018 and the equity cult has only grown since then and the government has claimed healthy accruals from LTCG on equities.

Of course, equity investors will be shellshocked if all equity gains are taxed at 30 percent. So that may not happen immediately but gradually the government may start turning the revenue screws, with measures such as increasing the holding period or even the tax rate in coming years.

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Ravi AnanthanarayananMoneycontrol Pro