Equity capital gains are free if you sell shares after a year. You don’t pay long term capital gains taxes for shares sold on a stock exchange.
But if you look at other “assets”, equity is getting a great deal:
Listed stocks are the only real asset class where, after just one year, you pay no taxes whatsoever.
Consider this scheme:
This is not an insane case. Recently, SEBI banned 260 entities for doing something like this, including the promoters of the troubled Bhushan Steel.
I will submit that you could do this over one year, but if it were any longer, say three years, then such manipulation would be very risky (because SEBI, which acts after one year anyway, will probably be able to detect and trace such manipulations).
One reason to provide the tax-free gains for equity shares was because the stock market was under-served and to promote investment. This has achieved its purpose. More investments are coming into the market than ever before. And the market is near or at all time highs.
The need now might be to promote longer term investments. As India matures, long term will mean three years, not one.
And then, we know that the government has no money. It’s running a huge budget deficit due to lower tax collections and stable expenditure (which it’s trying to cut because it is not able to earn enough by way of taxes).
We know that:
Given this, and given that we have a budget coming next months, here’s what I think should happen:
This would make perfect sense, and is quite a logical thing according to me. You buy and wait till three years after you’ve bought, then gains are tax-free. Otherwise, you pay capital gains taxes.
My Goodness, Deepak, are you Stupid? Who the heck will pay short term cap gains till three years?
I didn’t say you would pay short-term gains taxes. You will pay long term capital gains tax after one year. This is 10% of your gains, (or 20% if you index with inflation, whichever is lower).
So if you hold for a year, you still pay a lower tax rate. But it won’t be zero. For Less than a Year, nothing changes – the tax is around 15%.
If you hold for three years, it will be zero tax on gains.
Yes, it will. Firstly people will know that the budget will come in February, but only be applicable after March 31. So if you bought between April 2012 and March 2014, you want to sell your shares and reinvest them. (Why? Because your purchases prior to 2012 will still be tax free as they are three years or more away. If you bought after April 2014, you have to wait one year to get tax-free gains anyway, so no point selling now)
This is probably a small subset of people, but their selling and the general media outrage (because the media is known to get all sentimental about things like this) will cause some damage.
But realization will dawn very soon that:
So what if the market tanks? If it’s the right thing to do, it’s what should be done. Markets will go down and up based on what they want.
I think it should, but I have no inside information that it will. This is a great time to do it. This government has only four budgets left, really: 2015, 2016, 2017 and 2018.
If you think about it, 2016 or 2017 has to be a blockbuster budget. 2018 will be okay, because that’ll just ride the momentum. So the only budget to do a massive cleanup/kitchen sink is: 2015. That’s now a month away. This budget could be the one that is “horrible”.
If this is a budget to clean up the mess, I think we should increase the term for tax-free long term gains to a holding period of three years.
To subscribe to new posts by email, once a day, delivered to your Inbox:
Also, do check out Capital Mind Premium, where we provide high
quality analysis on macro, fixed income and stocks. Also see our
portfolio which has given stellar returns in our year, trade by trade
as we progress. Take a 30-day trial: