Budget 2018 – LTCG Tax @ 10%, Grandfathering Clause & Dividend Distribution Tax (DDT) on Equity Mutual Funds

by Shiv Kukreja on February 2, 2018

in Uncategorized

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Budget 2018 has reintroduced the long-term capital gain tax on equity shares and equity mutual funds. There were speculations about its comeback, but I never expected it to materialise, at least in this budget. Personally I believe cons of having it outweigh pros of having it, but it doesn’t matter at all. What really matters is how harsh this LTCG tax is and why there was no panic selling in the markets today. Let us try to find out.

Firstly, this is what the Finance Minister Arun Jaitley announced in his budget speech today – “I propose to tax such long term capital gains exceeding Rs. 1 lakh at the rate of 10% without allowing the benefit of any indexation. However, all gains up to 31st January, 2018 will be grandfathered. For example, if an equity share is purchased six months before 31st January, 2018 at Rs. 100 and the highest price quoted on 31st January, 2018 in respect of this share is Rs. 120, there will be no tax on the gain of Rs. 20 if this share is sold after one year from the date of purchase. However, any gain in excess of Rs. 20 earned after 31st January, 2018 will be taxed at 10% if this share is sold after 31st July, 2018. The gains from equity share held up to one year will remain short term capital gain and will continue to be taxed at the rate of 15%.

In view of grandfathering, this change in capital gain tax will bring marginal revenue gain of about Rs.20,000 crores in the first year. The revenues in subsequent years may be more.”

What seems a simple thing to read carries many ifs and buts behind it, and the most important here is the “Grandfathering Clause”. We’ll try to clear all these ifs and buts here, so let us take it one by one.

What is this ‘Grandfathering’ clause?

As per Wikipedia, “A grandfather clause is a provision in which an old rule continues to apply to some existing situations, while a new rule will apply to all future cases”.

In our case, whatever gains we have earned on our investments in equity shares or equity mutual funds (including balanced funds) till January 31, 2018 will be grandfathered, or will not be taxed at all. So, whether you sell your equity shares or equity mutual funds tomorrow, or between now and March 31, 2018, or even anytime after March 31, 2018, you will not have to pay any LTCG tax on your gains earned till January 31, 2018, if your holding period is more than 12 months.

So, please keep in mind, there is no need to panic in this situation, as there is nothing which is going to affect your gains till 31 January. There is only one thing that could affect your gains (future gains) adversely in this situation and that is your panic behaviour and nothing else. You should take your ‘sell’ decisions only if you think that other investors will panic and markets will move down sharply from here. Even in this case, your previous gains are not taxable and you would be able to protect your gains from probable future losses.

When will this 10% LTCG Tax come into effect?

It will come into effect from April 1, 2018 onwards. It is still a proposal and not applicable for the gains you book on or before March 31, 2018.

So, should we book our gains before it gets applicable with effect from April 1, 2018?

Absolutely NOT, there is no point doing it for this reason. Your long term capital gains earned till January 31 are 100% safe from this tax and it makes absolutely no difference to that portion of LTCG, whether you sell it tomorrow, or after April 1, or even after 2 years from today.

How would our long term capital gains be taxed if we sell them on or after April 1?

There will be 2 portions of your LTCG when your actually book your gains on or after April 1 – first, LTCG earned till January 31, 2018 and second, LTCG earned between February 1 and the date you sell your holding(s). First portion will be tax exempt, and second portion will be taxed at 10.4%, including 4% health and education cess.

What will be our cost of acquisition for the gains made after January 31, 2018?

There is a formula for determining your cost of acquisition for the shares or mutual funds bought on or before January 31, 2018, LTCG gains earned after January 31, 2018 and gains booked after holding them for more than 1 year. Here you have the formula:

The cost of acquisition will be HIGHER of:

a) Actual cost of acquisition, and

b) LOWER of:

(i) Fair Market Value of the shares/units as on January 31, 2018

(ii) Actual consideration received at the time of transfer

Let us take a look at the table below to understand it with four different scenarios:

picture1

How much LTCG is tax exempt?

LTCG upto Rs. 1 lakh per financial year is not liable to any tax, and you will have to pay 10% tax only on your long term gains over & above Rs. 1 lakh of exempt LTCG.

Like debt mutual funds, is there any indexation benefit available for calculating LTCG tax?

No, as the LTCG tax rate of 10% is considered to be on a lower side, indexation benefit to incorporate inflation effect has not been provided for in the budget.

Dividend Distribution Tax (DDT) @ 10% on Equity & Balanced Mutual Funds

Finance Minister Arun Jaitley has decided to tax your dividend income also which you get on your investments in equity mutual funds or balanced mutual funds. Here is what he announced in the budget:

“I also propose to introduce a tax on distributed income by equity oriented mutual fund at the rate of 10%. This will provide level playing field across growth oriented funds and dividend distributing funds.”

The onus of paying it to the government will not be on you. It will be the responsibility of the mutual fund which has announced to pay you this dividend, and it will be in the form of dividend distribution tax of 10%. This 10% will be deducted from the dividend announced and then dividend will be paid to you.

What’s your view on this reintroduction of LTCG tax and dividend distribution tax? Do you think it is going to have a substantial impact on our markets? Please share your views here. Also, if you have any query regarding any of the points mentioned in this post, please share it here.

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