The stock markets have seen a sharp correction in February. From the peak 36,283 points on January 29, the Sensex has slid to 33,703 on February 20 — a reduction of nearly seven per cent. Among other factors, one development has played its part in this fall: the announcement of the Long-Term Capital Gains (LTCG) tax on equity investments.
As per finance minister Arun Jaitley’s announcement during the Union Budget, LTCG above Rs 1 lakh on equity investments from stocks, mutual funds, and business trusts will now be taxed at 10 per cent. Gains on equity qualify as ‘long-term’ after a period of one year from the date of acquisition. This has naturally come as a dampener to equity investors, who had taken to equity mutual funds which would have allowed them to create wealth without having to pay taxes on their long-term gains.
The new rules come into play from April 1. Mr Jaitley also announced the grandfathering of equity returns up till January 31, 2018 — basically, an exemption from the new laws. Equity investments between February 1 and March 31 would continue to be taxed as per existing rules, that is, 15.45 per cent taxes on Short-Term Capital Gains, and no taxes on LTCG where Securities Transaction Tax has been paid. Despite the new tax, here are three ways by which smart investors can improve their returns and reduce tax incidence on their profits.
BOOK PROFITS PERIODICALLY & REINVEST
As per the new norms, you will be taxed on Long-Term Capital Gains above Rs 1 lakh. This means that gains up to Rs 100,000 are still tax-free. Ordinarily, it would take most retail investors, who invest via the SIP route, several years to accumulate gains more than Rs 1 lakh. For example, if you invested Rs 5,000 a month via an SIP with a handsome returns expectation of 15 per cent per annum, your corpus in four years would be Rs 3.30 lakh over an investment of Rs 2.4 lakh. The LTCG here are still well under the limit of Rs 1 lakh. Therefore, they can be redeemed without tax. Then, they can be reinvested in a fresh equity purchase and allowed to earn market-linked returns. This method would require active portfolio management. It’s not the ‘fill it - shut it - forget it’ style of investment that SIPs usually provide. However, being proactive would certainly help you save a lot of tax.
BUY MUTUAL FUNDS INSTEAD OF STOCKS
Researching, buying, holding, and selling of stocks is an activity that requires considerable expertise and knowledge of the stock markets as well as the companies you are buying. In short, it is not for everyone, and even experts get it wrong from time to time. The periodic sales of stocks also needs you to keep track of your LTCG and losses, as well as STCG and losses. You could avoid the pain altogether by buying equity mutual funds. Let a fund manager do the hard job of deciding what to buy, what to hold, what to sell, and when. As your portfolio is managed via your mutual fund, you need to worry about your taxes only at the point you decide to redeem your units.
INVEST IN DIRECT MUTUAL FUNDS
The concern with LTCG tax is that your returns are lowered. One way to increase your margins is to buy ‘direct’ plans. Mutual funds are sold in regular and direct plans. Regular plans are sold by aggregators, distributors and agents. Direct variants are sold by the fund house with no intermediary. Because of this, direct plans have a lower expense ratio. Sometimes, the difference is more than 1-2 per cent. If you are investing to create wealth in the long term, a difference of 1-2 per cent can make a huge difference. For example, a monthly SIP of Rs 5,000 for 20 years with a CAGR of 17 per cent will create a corpus of Rs 1.01 crore. If the returns were only one per cent less, at 16 per cent, the same SIP would create a corpus of Rs 87.4 lakh. If you are confident of your investment plan, have been advised well, and would like to earn higher returns, you can switch from regular mutual funds to direct ones. This would increase your margins. Naturally, this would also increase your taxable income. But that’s a good pr-oblem to have.
— The writer is CEO, Bank Bazaar.com