Arun Jaitley has Fathered a Budget that has got People Wondering what Grandfathering means

Earlier this week, Indian Finance Minister Arun Jaitley presented the Union Budget for 2018-19 in the parliament. Jaitley announced the end of the exemption for equity investments (including equity mutual funds) from long-term capital gains tax. Starting July 31st 2018, all equity gains exceeding 1 lakh rupees will be taxed at 10% if they are redeemed after one year of purchase.

The exemption, which was announced in 2004 by the Congress government, was designed to incentivize investment in the Indian equities market.

What does this mean for mutual fund investors?

(A:It means that you should probably start using SimpleMoney to calculate your Capital Gains taxes, because things just got a bit complicated.)

If you invest in equity mutual funds and redeem your funds within one year of the purchase date, you are required to pay a short term capital gains tax of 15% of the amount you have gained. If you redeemed your funds after one year of purchasing, starting in 2004, you were not levied any long term tax on the gains.

However, as per Jaitley’s announcement yesterday, if, after July 31, 2018, you sell any equity fund that you have had for longer than one year, you will be required to pay a 10% long term capital gains tax on the gains. A “grandfathering” clause in this announcement states that for all funds purchased before January 31, 2018, you will only have to pay long term capital gains tax on gains made after January 31, 2018. This means that all gains that you might have made between 2004 and January 31st 2018 will not be taxed, a clause that many consider to be a valuable concession from the government.

Here are a few scenarios:
LGCT Scenario

Scenario A: You purchased an equity mutual fund for ₹100 on 25th February 2017. The value of the fund on January 31 2018 is ₹150, making your gains ₹50. If you sell the fund on August 1st, 2018 for 190, you will pay a 10% long terms capital gains tax on a ₹40 gain, and not ₹90, which is what it would have been without “grandfathering.”

Scenario B: You purchased an equity mutual fund for ₹100 on 1 April 2017. The value of the fund on January 31 2018 is ₹150. You sell on August 1 2017 for ₹130 - there is no capital gains tax because there are no gains after January 31 2018.

Scenario C: You purchase an equity mutual fund on 2nd February 2018 for ₹100 and sell on 1 April 2019 for ₹190 - you pay a 10% long term capital gains tax on the gain - ₹90.

Should I stop investing in equities and equity mutual funds?

No. The reintroduction of the long term capital gains tax has been controversial. However, this doesn’t necessarily mean that equities have now become a bad financial tool to invest in. Long term capital gains taxes for many other financial assets only kick in after 3-5 years, whereas for equities investments it’s after just a year, which means you can save on taxes as early as 1 year after investing in the markets.

If your gains across all equity investments do not exceed ₹1 lakh, you will be exempt from this taxation. In his press briefing after the Budget, Jaitley stated that he didn’t think the reintroduction of long term capital gains tax would impact the middle class. The exemption, he said, had been a “subsidy for the richest” and had largely benefited corporations.

What the reinstatement of the Long Term Capital Gains tax could possibly do is make Indian investments less attractive to foreign investors as the total taxation on equities becomes less competitive when compared with other emerging Asian markets. However, for domestic, individual investors, equities markets are still one of the best places to invest our money, especially when compared with capital gains taxation in other countries.

But wait, what if I move my funds to a Dividend, rather than Growth Option? Does this mean that my gains won’t be taxed?

Unfortunately not. The Finance Minister, smart man that he is, has also proposed a tax of 10% on income distributed by equity oriented mutual funds with dividend options.

Why has the government reintroduced the Long-Term Capital Gains Tax?

The exemption introduced in 2004 was seen as a way to incentivize Indians to invest in the financial markets, at a time when many households were saving their money in the form of real estate and gold. The government wanted to provide an incentive for people and corporations to enter the market. Today, the market has matured, and the “bull” market that we are experiencing today makes equities investment attractive even without the tax exemption. In short, there is no longer an incentive for the government to incentivize Indians to invest in the stock market.

Is this budget a populist, election budget that disadvantages the middle class and investors?

While it might seem so, we believe that this is not an entirely accurate portrayal of the budget. Yes, the budget focuses largely on proposals and announcements that had little to do with investors and corporates. For instance, it announced the world’s largest healthcare program designed to give the poorest of Indians affordable healthcare. Jaitley also increased the MSP (Minimum support budget payment) to farmers. It is believed that the funding for these programs will come from the revenue in long terms capital gains taxes. In 2017-18 alone, ₹3.67 lakh crores was the exempted income on long term capital gains, and it is anticipated that in the first year, the government will gain ₹20,000 crore in the form of long term capital gains tax.

But these programs seem fair, given that India’s income inequality is growing at a rate faster than many countries. And if The Economist has anything to say about the middle class, it’s that India’s middle class is not as big as it might expected to be because of the widening income inequality gap in the country.

What might not be entirely fair is that that the STT, Securities Transaction Tax, introduced in 2004 by then Finance Minister P. Chidambaran in lieu of the Long Term Capital Gains tax, is still in existence and was not revoked by Arun Jaitley yesterday. This means that every transaction of equities listed on the Indian stock exchange, after one year of purchasing (including equity mutual funds) will continue to pay both STT and Long Term Capital Gains taxes, which seems like paying the same tax twice. Hasmukh Adhia, Revenue Secretary, refuted this idea by saying that STT will continue to coexist with Long Term Capital Gains because the capital gains (both short and long term) for equities are far lower than what it is in other asset markets. It's also a lot lower than it is in other countries around the world.

Okay, but I'm still nervous. What should I do?

The return of the long term capital gains tax was anticipated (and favored) by many who argued that taxation on gains made in the financial markets is only fair. Regardless of the tax, equity investments in India are still a good bet to allocate your assets to. Capital gains tax calculations, which were already quite complicated to begin with, have become even more complex and convoluted. Don’t worry about doing this by yourself - SimpleMoney will automatically calculate your gains and tell you how much tax you owe on each of your funds. We have spent a long time figuring out the term grandfathering so that you don’t have to! Rest easy, have a good weekend.

Track your mutual funds automatically at SimpleMoney.