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LTCG and its impact on Long Term Equity Investments

Budget 2018-19 created a lot of buzz after reintroduction of LTCG tax on Equities.The Finance Minister proposed to levy a 10% tax on the capital gains earned above Rs 1 lakh on equities that is held for more than 1 year. It doesn’t take into consideration the indexation benefit i.e. Long Term gains wouldn't factor in the inflation. Thankfully FM has also introduced a grandfathering clause which means that any long-term capital gains till 31st January 2018, on old purchases would be exempted. Short Term Capital Gains tax of 15% and Securities Transaction Tax (STT) remains unchanged.

LTCG Tax: Reintroduced after 14 years  

In October 2004, as an attempt to encourage long-term investment in equities, the government had abolished LTCG tax replacing it with securities transaction tax (STT). Up to September 30, 2004 LTCG was taxed at 20%. The government has now brought back LTCG Tax on equities in the Union Budget 2018-19 at 10% of gains while STT has also been continued.

Grandfathering Clause to exempt past gains 

The grandfathering clause basically means the exemption granted to existing investors or gains made by them before the new tax law comes into force. The government has introduced limited grandfathering clause in Budget 2018-19 in respect of protecting gains realized on a mark to market basis up to January 31, 2018. However, an increase in share value post 31st January 2018 would be brought within the tax net. This is in line with the Government’s intent not to introduce taxes with retrospective effect and to protect any exodus from the Indian markets. 

Impact of LTCG on Existing and New Investors

Existing Investors:
If an investor sells stock or equity mutual fund held for over a year after 1st April 2018, LTCG tax will be calculated on the basis of the acquisition price or high price of 31st January 2018, whichever is higher. For example: a stock purchased on 15thJanuary 2017, for Rs 100, which touched a high of Rs 200 on 31st January 2018. If it is sold after 31st March 2018, LTCG will be calculated based on the high price of 31stJanuary 2018 as it is higher than the acquisition price. 
Investments made before 31st January 2018 considering various scenarios:

New Investors:

Any shares purchase or on after 1st Feb 2018 will be subjected to STCG (15%) or LTCG (10%) based on the holding period.


Conclusion: LTCG is reality and let the ‘compounding effect’ to do the magic
Despite the LTCG tax, Equity as an asset class still remains the best investment instrument for long-term wealth generation. Sensex has delivered 15.5% CAGR in last 30 years, while some of the individual stocks have given even higher returns than this. 
The impact of LTCG tax would be higher on investors who would churn their portfolio often while it would be lower for investors who were to hold on their investments for a longer period.  
If we assume annualised equity return of 15% and see the impact of LTCG for a stock held for 30 years / 15 years / 5 years, the impact of LTCG tax at the end of the holding period is lowest for 30 year period.

For Example: If a person invests Rs.100 in a stock which compounds at 15% and were to hold it for a period of 30 years - taking the LTCG into consideration then the post-tax CAGR at the end of 30th year will be at 14.6% (see table below). The post-tax CAGR if the investment were to be held for 15 years and 5 years period will come down to 14.3% and 13.8% respectively.

So the best advice for retail investors would be to hold on to their investments for a longer period and let the ‘compounding effect’ to do the magic.

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