Budget 2018: Reduction in corporate tax, long term gains tax will make investments in SME stocks lucrative

Finance Minister Arun Jaitley on 1 February introduced a 10 percent tax, Rs one lakh if gains exceed in a year, on Long Term Capital Gains (LTCG) due to sale of equity shares in a company or units of an equity-oriented fund or units of a business trust in the Union Budget 2018. The tax has been brought in by inserting a new section 112A in the Income Tax Act, 1961. In case of equity shares or equity-oriented funds, the holding period for an asset to be considered long term is one year. Until now, if you had such assets and decided to sell them, the capital gains were tax free. However, now they would be taxed at 10 percent if the gains exceed Rs 1 lakh in a year. What needs to be noted is the new ‘grandfathering’ clause which means what is taxed is the gains from 1 February, 2018 and not what has already been earned. Capital gains are the difference between the cost of acquisition of an asset and the price at which you sell them. Thanks to the grandfathering clause, the difference will be computed between the cost of acquisition or the fair market value as on 31 January, 2018 or whichever is higher, and the selling price. This means the gains till date are exempted, whether they are realised today or not. In the previous budget, tax on dividend income over Rs 10 lakh in the hands of the recipient was brought in, though the same is already taxed in the hands of the company. The rationale behind doing this is to tax people who hold large investments in the above mentioned assets, ie. high net-worth individuals and corporates who are in the highest tax bracket and were making use of the lower tax or no tax provisions. [caption id=“attachment_4332449” align=“alignleft” width=“380”] A file image of a stock broker.[/caption] This is proved by what the finance minister has pointed out, “The total amount of exempted capital gains from listed shares and units is around Rs 3,67,000 crore as per returns filed for AY17-18. Major part of this gain has accrued to corporates and LLPs. This has also created a bias against manufacturing, leading to more business surpluses being invested in financial assets.” The reduction in income tax for companies whose turnover is less than Rs 250 crore, i.e. SME companies from 30 percent to 25 percent, along with the tax on LTCG from equity shares and equity oriented funds will make investments in SME stocks lucrative. The value of these companies will increase as the future earnings projections will go up because of the reduced tax, and the other measures of the government to encourage lending to these companies. We could also see more such companies being listed, as the interest in them would be high. Increase in focus in these companies will also bring in increased liquidity to these stocks, and also force better reporting and professionalism in the way they are run, improving the overall efficiency of the markets, and reducing the volatility in these stocks. The impact would be minimal in taxpayer’s hand. The tax is on gains over Rs 1 lakh per year, and if the gains made was from today, there is plenty of time for the returns to adjust themselves. And considering that the alternate long term investments are taxed at 20 percent, it still makes these investments attractive. It will also encourage people to hold on for a bit longer, as exiting comes at a cost, and add a bit of stability to the market. Considering the above facts, it seems introduction of the LTCG on equity shares and equity oriented funds may not be as bad as it may sound. Click here for full coverage of Union Budget 2018.