All you wanted to know about LTCG taxes on equities!
“In this world, nothing can be said to be certain, except death and taxes.” – Benjamin Franklin
In the latest budget, Finance Minister Arun Jaitley, reintroduced Long-term capital gain tax for equity investments starting 1st April 2018. For some time now, It was widely rumoured that such a tax will come into effect. So, when it was actually introduced, it did not come as a huge surprise. Definitely, it means that gains from equities will no longer be totally free, it DOES NOT mean that equities should be avoided now.
I was asked by some people if equities are no longer the preferred option for long-term wealth creation. The answer is an emphatic NO.
Here, I discuss what is LTCG tax, how it affects equities, how the LTCG tax on equities compare with other asset classes and what should equity investors focus on.
What is long-term capital gain tax?
For most financial investments, whenever you redeem/sell the investments, you receive more than what you initially invested. The difference (the profit) is the gain in capital, also called capital gain. Now, this gain is taxed. Earlier, for equity investments (direct stocks or equity mutual funds), if you had held investments for more than 1 year, all the gains were tax-free. As per the latest budget:
- If you hold equity investments for 1 year or more, you will have to pay long-term capital gain tax @ 10%.
- However, the above tax is applicable only if your long-term capital gain from equity is more than INR 100,000 during the financial year.
- So, for example, if your long-term capital gain is 500,000, the LTCG tax will be (500000-100000) *10% = INR 40,000.
- The LTCG tax will come into effect from FY 2018-19.
- For the purpose of LTCG tax calculation for equities bought on or before 31st Jan 2018, the price as of 31st Jan 2018 or actual price when purchased, whichever is higher, will be taken as the purchase price.
How does LTCG tax for equities compare with other asset classes?
How does LTCG tax on equities affect attractiveness of equities?
Certainly, equities are less attractive than what they were earlier. However, equities still remain a very attractive investment option as even after the imposition of taxes, post-tax return from equities should remain between 10% to 15% for long-term investors. This will still be the best asset class for long-term holders. Further, an exemption of 1 lacs per year is a welcome relief for most investors. For me, equities and equity mutual funds remain the best investment option from long-term perspective.
Just to summarise:
- Taxes are natural by product of a profitable investments. As we say, invest regularly, invest systematically and ignore the noise
- Imposition of LTCG tax can potentially reduce post-tax return from equities and equity mutual funds. So, the gap between post-tax return from equities and other asset classes will narrow. But, equities will continue to generate significant wealth for long-term equity investors who are investing in a systematic manner.
- Lower holding period for LTCG applicability, exemption limit of 100000 and a lower tax rate of 10% means LTCG tax on equity is still lower compared to other asset classes.
- Investors should aim to reduce their LTCG tax burden by periodically booking profit to the tune of 1 lacs every year. Remember, there is no exit load in most mutual fund schemes after 1 year and one can sell and then again buy the next day. This way they can maintain the equity exposure while also taking the benefit of 100000 exemption limit.
- Remember, LTCG tax is payable only when you sell. One should look to defer the LTCG tax by increasing holding period of equity mutual funds. One should not get confuse between the point above and increasing holding period. Both these steps will help in reducing LTCG tax on equity.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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