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Are Long-Term Taxes on Mutual Funds Going to be Introduced in the Next Fiscal Budget?

There are only a few weeks left before the announcement of the fiscal budget. Market participants are now looking for possible changes that may be announced, which would affect their investment decisions. 


Some market participants anticipate modifications to Long-Term Capital Gains (LTCG) tax on equities. This is to cover the reduction of revenues due to the implementation of the Goods and Services Tax (GST). 


Several analysts believe that the implementation of LTCG on equities may prevent investors from investing in this asset class. In addition to retail investors, LTCG on equities may deter institutional investors from investing. Such investors have pumped in over INR 100 crore in the equity markets during the last year. 


Current laws 


Equity mutual funds or shares are classified as capital assets. If investors stay invested in these instruments for at least one year, the gains on the sale of these are known as long-term capital gains. 


Presently, long-term gains on equity schemes or shares are not taxable. The short-term shares or equity mutual fund taxes are levied at a rate of 15%. 


Impact of LTCG on investors 


According to the existing laws, there are no taxes on mutual funds equity schemes when investors hold these for a period exceeding 12 months. Long-term capital gains are exempt from taxes, which is an important driver for investments in this asset class. 


If you exit your equity scheme investment before 12 months from the date of purchase, short-term capital gains mutual fund taxes at the rate of 15% is levied. However, if the government modifies LTCG regulations in the fiscal budget, investors will have to pay taxes even if they hold the mutual fund units for more than 12 months. 


The implication of the levy of LTCG may be like a death knell for equity investors. It may have an adverse effect on the market sentiments. Investors may stay away from shares and equity mutual funds and invest in other asset classes. Since demonetization, investors have increased investments in the mutual funds and equity markets. Inflows in such assets were estimated at INR 20000 crore in November 2017 and domestic institutional investors pumped in more than INR 8000 crore in the stock market in December 2017. 


Some market participants also anticipate changes to the holding period of equity mutual funds to benefit from the exemption of LTCG. It is forecast that the fiscal budget may modify the holding period increasing it to three years from the existing period of one year. 


To bring equity investments at par with other asset classes, the holding period is anticipated to increase. However, if such a modification is implemented, investors will be deterred from investing in equity mutual funds or direct equities. This is because the advantage of this asset class over others will no longer be available. 


Possibility of such changes 


The implementation of GST has restricted the manoeuvrability of the regulatory authorities with respect to indirect taxes. Furthermore, the revenue from GST was at its lowest in November last year. As a result, the government is under significant pressure to increase its revenue shortfall. The fiscal deficit during the first eight months of the fiscal year 2017–18 has reached 112% of the entire year’s target deficit. Some reports forecast the government to earn as much as INR 50000 crore per year if laws related to taxes on mutual funds and equities are modified. 


Is it the right time for such change? 


Most market participants believe such changes would negatively influence investor sentiments. Another question is whether it is the right time to bring about this change. The policy changes made by the government have improved investor sentiments with a positive outlook for the industries. Therefore, if this change is introduced in the fiscal budget it would seem like anti-investor, which is why now is not the right time for the modification.


Irrespective of whether LTCG is introduced in the new fiscal budget or not, shares and equity mutual funds remain a lucrative asset class. These products deliver the highest returns when held for a period of five to ten years.


With a large number of available mutual funds, investors may find it difficult to make the right choice. To overcome this difficulty, they may use ARQ, the proprietary investment engine in Angel Wealth’s mobile application. It uses scientific algorithms and quants to match recommendations to investors’ risk appetite and financial objectives. The entire analysis is automated eliminating all human bias and intervention. 

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