Budget 2016: Should FM tax long-term gains on equity?

Speculation has been rife of the government planning to raise the period of holding of equity shares for calculation of long-term gains. Instead of allowing holding period of more than one year to qualify as long-term gain, three years of holding may be considered. While there is no way to read in to finance ministerArun Jaitley’s mind beforehand, it may be worthwhile to understand the implications if that happens and the reasons for this anticipated change.

In Budget 2014, the finance minister raised the period of holding for debt funds from one year to three years to qualify for long-term capital gains. Possibly preparing the investor for the road ahead? Equity shares and equity mutual funds are the only capital assets that enjoy a shorter holding period of one year. All other capital assets are considered long-term when held for longer than three years. Also these are the only assets which enjoys tax-free long-term gains. The period of less than 12 months (instead of 36 months) for being considered as short term capital asset for listed securities was introduced in the assessment year of 1995-96. These tax rules have been in place since many decades.

Allowing tax free long-term gains and a shorter holding period, helps attract retail investors to the stock market. During the mid-90s, these rules were introduced to bring the retail investor to equity markets. However, a large number of the super-rich, who have capacity to invest in large volumes, have been taking the benefit of this tax rule, earning significant tax free long-term gains. Also our equity markets have been through immense volatility in the past months. A longer term horizon for equity investment means stable inflows into the market. Experts have held that having a one year time frame is also leading to rise in black money. Some investors have been making significant long term gains and routing them through hawala mechanism.

While raising the holding period may be a prudent economic decision, it may also spell bad news for the markets.

Already under pressure from foreign institutional investment (FII) outflows, the market is not likely to take this news positively. However, if you are a retail investor, holding your shares in the 3-5 year time frame is a wise thing to do. So, do not sell your equity or mutual fund holdings in panic, wait for your gains to ripe.

It is time for the finance minister to consider some hard measures to reign in the economy, invest for its growth and keep fiscal deficit in check. Taxing long term gains would help in increasing tax collections. However, the finance minister will attempt to keep a fine balance between doling out tax sops and increasing taxes as well as maintaining sound fiscal discipline.

This article was published in The Financial Express on 23rd February 2016.

The writer is chief editor at www.cleartax.in & a chartered accountant

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