Analysts believe that the exemption for long-term capital gains on equity investments should be expanded to account for inflation, rising income levels, and to encourage more investors into equity markets.
Investors are usually nervous before each Union Budget. This time is no exception, with investors keeping a close eye on news surrounding the Budget for 2023-24, hoping that finance minister Nirmala Sitharaman deals them a good hand. Here are some of the assumptions.
Most investors struggle to understand the threshold limits for determining whether an asset is classified as long-term or short-term in order to determine tax liability. This is due to the fact that the holding period for terming if an investment is long-term varies by asset class. Abhishek Soni, co-founder and CEO of Tax2win.in, hopes that the budget will make things easier. "At the moment, all capital assets have different holding periods and different tax rates," he explained.
While units of debt funds must be held for a minimum of three years to be considered a long-term capital asset eligible for a reduced tax rate on booked profits, units of equity funds must be held for one year, and real estate and unlisted stocks must be held for two years.
"Bonds are a short-term asset class, and equity is a long-term asset class," said Balwant Jain, a chartered accountant in Mumbai. The holding period required to classify an investment as a long-term capital asset for tax purposes should be long enough to encourage long-term investments in equities." He proposed that debt fund units be considered long-term capital assets if held for one year before sale. He suggested that it should be three years for equity mutual fund units and five years for real estate.
Long-term capital gains exemptions
Individual investors are exempt from paying tax under current rules if their long-term capital gains on stocks and equity mutual funds do not exceed Rs 1 lakh in a fiscal year. They are taxed at 10% above this threshold. Mihir Tanna, associate director (direct tax), S K Patodia & Associates, a chartered accounting firm based in Mumbai, argued that the exemption limit is insufficient. "The limit should be increased to Rs 2.5 lakh or higher." Individual income is exempt from income tax if it is less than Rs 2.5 lakh in a fiscal year," he explained.
Analysts believe that the exemption for long-term capital gains on equity investments should be expanded to account for inflation, rising income levels, and to encourage more investors into equity markets.
"Many times, investors are seen dabbling in stocks and units of equity mutual funds under the guise of booking profit simply because they have been held for one year and a 10% tax is applicable on long-term capital gains above the Rs 1 lakh exemption limit." However, there is a need to encourage genuine long-term investing through appropriate tax soaps," said Nitesh Buddhadev, chartered accountant and founder of Nimit Consultancy. He added that capital gains should be tax-free if investments in listed stocks, unlisted stocks, or equity mutual funds are held for at least ten years.
Jain, on the other hand, has a different idea for encouraging long-term equity investments. “Currently. Long-term capital gains on equities exceeding Rs 1 lakh in a fiscal year are taxed at a flat rate of 10%, regardless of how long you held them. "There is a need to allow indexation benefit when computing long-term capital gains on investments in equities and equity mutual fund units," he stated.
The indexation benefit of equity investments must also be viewed in light of the higher level of risk that equity investors take when compared to fixed income investors.
"The capital gains exemption of Rs. 1 lakh is only available in the case of long-term gains from equity shares and equity-oriented mutual funds," Soni explained, adding that it is expected to be extended to long-term gains from debt-oriented mutual funds as well.
Some investors may choose not to invest in equities at all. Such investors must pay taxes on profits earned from long-term investments in debt funds and are not eligible for an exemption.
Rate adjustments are due.
Short-term capital gains on stocks are taxed at 15%. This was widely accepted when the minimum income tax rate was 10%. "With the minimum tax rate reduced to 5%, investors in that income tax bracket find the 15% rate punitive." Small investors should be given some leeway, according to Jain.
Investors anticipate that the finance minister will offer some relief on the tax rates applicable to capital gains realised on debt investments. Long-term capital gains on debt funds are currently taxed at 20%, with short-term capital gains taxed at the investor's slab rate. However, during the pandemic period, interest rates fell and inflation rose. Even though interest rates have risen in the last year, there is speculation that they will fall in the medium to long term. Expected low interest rates and the current high tax rate leave very little in the hands of investors after taxes.
There is clearly a long list of prayers from various sectors of the economy in advance of the budget. It will be interesting to see how many responses there are.
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