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Long Term Capital Gains Tax & Its Impact on Retail Investors

On February 1, 2018 in the last full year union budget by the NDA government (Budget 2018), has caused quite a ripple in the minds of middle class investors. The government has introduced the Long-term capital gains tax of 10% (+ Cess) on the Equity Investments with two conditions:

  1. Capital Gain realized in any given financial year more than INR 1lacs will be taxed
  2. All the gains till the date of January 31, 2018 will be grand fathered

Now just after the announcement all the investors new/ old or small/ Big started making complain about this new tax proposal. Though some of us were looking to understand this in a better manner and its impact on us before commenting on the policy change. I have received multiple calls from family and friends regarding the same. Here is my summary based on the FAQs published by the CBDT (Link:https://www.incometaxindia.gov.in/Lists/Latest%20News/Attachments/216/FAQ-on-LTCG.pdf ) on this topic.

First and foremost, the changes in Budget 2018 are applicable from next financial year only. Therefore, any long-term capital gain (LTCG) you realized till March 31, 2018 will continue to be tax free. If you plan to sell your investments in Equity Shares or Equity oriented MFs which has been invested for more than 1 year, the gain on such investments are still tax free till March 31, 2018.

Treatment of LTCG till now

Till now the treatment of the LTCG was very simple. I just need to remember the date of investments to check when my investment period will be more than a year so the LTCG tax will be zero on my investments. This was very simple to manage my portfolio. Though the new change will complex the things.

Treatment of New Investments from Feb 1, 2018

Now for all our new investments since we have to pay tax on our LTCG, we should not only remember/ keep record of investment date but also keep a track of price at the time of investments. This means too much of paperwork for all of us. If you are small investor and going to market via SIP route this work becomes cumbersome.  Good part is that every time you sell your investments and realize LTCG, you do not have to pay the tax. You can accumulate the LTCG in respective financial year and need to pay tax only if overall LTCG is higher than 100,000.

Another benefit to this process is that you can adjust your gains with your long-term capital loss (Equity or Debt) in same financial year. If the long-term capital loss in any financial year are higher and are not adjusted against gains, it can be forwarded up to next 8 years. This is similar to the treatment of short term capital gain tax. Though to manage this the amount of paperwork will increase as well as the fees of your CA will be higher.

Treatment of Old Investments from April 1, 2018

If you thought the last segment was increase work you then hear this. For investments made before or on Jan 31, 2018 when sold after 1 year will require three inputs to calculate your LTCG due to clause of grandfathered gains. You need to keep a track of purchase price of your investments (PP), price of investments on Jan 31 (GP – grandfathered price) and the selling price of your investments (SP). The calculations need to be done as below:

  1. Selling Price (SP) > Purchase Price (PP) and Selling Price (SP) < Grandfathered Price (GP); Tax liability NIL
  2. Selling Price (SP) < Purchase Price (PP) and Selling Price (SP) > Grandfathered Price (GP); Tax liability NIL
  3. Selling Price (SP) > Purchase Price (PP) as well as Grandfathered Price (GP) and PP > GP; Calculate gain by taking difference from Selling Price and Purchase Price
  4. Selling Price (SP) > Purchase Price (PP) as well as Grandfathered Price (GP) and PP < GP; Calculate gain by taking difference from Selling Price and Grandfathered Price
  5. Selling Price (SP) < Purchase Price (PP) as well as Grandfathered Price (GP); Calculate Long Term Capital Loss by taking difference from Selling Price and Purchased Price

All the clauses from last section will be applied here like wise. Capital gain >1lacs are taxable and capital loss can be adjusted against your other capital gains as well as can be carry forwarded if required.

Impact of LTCG Tax

Now we have understood the calculations of the LTCG, let’s look at its impact.

  1. Small investors: Equity investments INR 10lacs. Effectively even at 10% return on Investments the total LTCG will be =< INR 1lac exemption limit so the impact is minimum for such investors.
  2. Medium investors: Equity Investments INR 11-25lacs. There will be possibility of some LTCG tax but can be managed with
    1. Intelligent churning of investments to make sure every year we rebase some of the returns while keeping yearly LTCG <INR1lacs
    2. Splitting the Investments in name of family members to keep this small
  3. Big Investors: Equity Investments INR 26lacs – 1 Cr. LTCG will be applicable with limited options to rescue it
    1. NPS to rescue you from the immediate taxation, it will be very attractive to keep your retirement corpus in NPS accounts to avoid any capital gain tax till your retirement. If we expect India to follow the path of developed nations, in future we can expect it to be an account like 401 account in USA
    2. ULIPs can be useful as Single Premium ULIPs have cost of 6% in first year and roughly 2-3% yearly afterwards against fund management and Mortality charges. You can top up the ULIP with additional investments and can switch between Equity/ Balanced/ Debt fund etc without any tax incidence. Though the return of ULIP funds can be average and not like Small/Mid cap MFs but still reasonable specially with no tax after long term of 10+ years
  4. Large Investors: Equity Investments INR 1 Cr+, LTCG will be applicable most probably and it is less avoidable.

Therefore, unless we move into the category of Large Investor category, there is relatively less to worry about. Also, we do not know if LTCG tax is here to stay or the relaxation of INR 1lac will be hardcoded in future as well. Let us wait and see how future unfolds and not panic.

Hope this helps! Happy Investing.

Investment Objectives & Advice

Path to Financial Independence: 4 ways to increase your investment income

Almost 5yrs back I wrote this article about financial independence( https://eduform.in/2011/08/21/path-to-financial-indipendence-power-of-investing/). At that time, I was young, immature and new to the whole corporate world. Today I feel that the frustration at that age was an eye opener for me. I have been climbing on the corporate ladder and understanding the various facets of the economy/business. If you read the news related to market and corporate world, it is quite common these days to find various companies which are going through the tough phase. Most of them are struggling to find the new sources of revenue growth, while others are finding it difficult to make the business profitable. Job security is no longer provided by companies; And it should not be expected as well. In such an environment it is becoming more and more important to achieve the financial independence than ever before.

Over the last decade India has produced huge number of engineers and MBAs from various institutes. In such scenarios, one thing which due to happen was oversupply of job seekers vs job requirements. Currently the employment market is going through a phase of correction and it might continue for some more years, as the global markets are slowing down, lot of companies are going slow in their hiring schedule. It has become quite common to see few of our acquaintance are asked to leave the firm for various reasons. Big corporates are announcing that they will lay off XXX employees during this year. It is important that we should plan to de-risk yourself from the dependencies on job to fund your routine expenses.

Last time I shared the three options which we can leverage to achieve financial independence; Part time professional services, Owning a business and Investments. Though as you grow in your career, the demand from work side keeps increasing and managing the part time work might be challenging specially after marriage :). Similarly, B business ownership is good but it is challenging either on time front or on the initial investment front. Investments is the easier way out but it is also time consuming and risky if you don’t do it right. As I relied a lot on investments compared with other 2 options, let me share few pointers to get you in right direction.

Take the first step; Invest in Yourself – We Indians have a great habit of being miser and fight for discounts everywhere. We plan our vacations based on flight/hotel discounts instead of feasible dates. Though in case of investments, we should plan and spend money on investment advisor upfront instead of opting for old school agents/brokers whose interest lies in generating more commissions for themselves vs importance of your needs. Do spend 1-5k at least once to consult a good financial planner and prepare a roadmap, after that you can do a review again after couple of years. It should help you plan your finances better:

    • Proper insurance planning for health/ life
    • Sufficient investment as emergency corpus in liquid funds
    • Loan planning for buying car/home
    • Future goals e.g. Child education, wedding, retirement etc.

Be Tax Efficient: for employed people, it is impossible to escape taxes. Though we can definitely optimize our tax outgo. Tax paid is the money lost, which is never going to come back so make sure to spend 10-30hrs a year for tax planning/payment and filing of returns and have a good CA to help you on this.

    • Keep it clean and keep all the records of relevant statements and details
    • Try to leverage the benefit of capital gain taxes instead of income tax by moving your investments from FDs/RDs to Debt MFs
    • Utilize the tax saving provided under various sections for our investments in PPF/EPF/ELSS/Insurance/NPS etc.
    • Plan your investments with a point of view on tax incidence. E.g. you can split the ownership of your house with your spouse to get the full benefit of tax deduction on interest paid. Or in case of Debt Funds if you buy them in Feb/Mar you can get 4 yrs of indexation even if you hold the funds for just little over 3yrs.

Educate yourself: Education is a continuous process especially in the current scenarios where things keep changing every few years. Also, Money is one subject which is not taught in school and college. Some sources which can help you get better understanding are as below:

    • Read magazine (Outlook money, Money today etc.)
    • Newspaper (Mint, ETWealth etc.)
    • Attend sessions or talk to an experienced person, to learn things on personal finance.

This will bring the change in your overall behaviour/perspective. Read books on investments, personal finances.

Do it Yourself: Once you gain some expertise start doing things by yourself, it not only reduces the cost for you but also can be more beneficial in long run. E.g. if you buy MFs under direct plan yourself you will get atleast 10-25bps extra return which can create additional lacs for you in savings in future. You can also stop seeing the investment advisor frequently and do it only once after couple of years.

Above 4 things will not only help you plan for your future in more meticulous manner but also take away worries of contingencies of medical cost or job loss etc.

Happy Investing!!