Budget 2018 and LTCG Tax explained: Simple, concise, actionable insights (Short version)

Posted By : Kushal Kothari
Tags :  Tax Budget 2018

The Budget session of the Lok Sabha - that day of the year when your parents, siblings, colleagues and everyone else gets involved in an economic debate with regards to the effects of a 2-hour speech delivered by one of the most, if not the most, important cabinet minister, The Finance Minister. 

Every media house wants to be out with a summary/brief of the highlights of the budget. Though these days, WhatsApp and Facebook beat them hands down in the race to get first to the reader. We thought it is important to share our thoughts with you as well, with a focus on actionable insights we can draw for our users. Today, we focus on only one aspect of the entire budget; One that affects you as a user/reader of this portal the most - The re-introduction of the Long-term Capital Gain Tax or LTCG tax for equity-oriented investments.


What is LTCG? - Based on the tenure of your investment, gains from stocks/mutual funds are classified as long-term or short-term capital gains. For debt funds, the threshold for classification as LTCG is 3 years, and for equity funds, it is 1 one year. More about this here.


What changes? - The tax on Long-term capital gains has so far been 0% for all equity or equity oriented mutual funds. With the new rule in place, Long-term gains greater than Rs.1 Lakh, will be taxed at 10% starting 1st April 2018. The purchase cost for calculation of gains for taxation will, however, be revised to higher of (1) the actual purchase NAV and (2) the NAV of the scheme as of 31st January 2018. The last provision has been the most amusing part of the announcement, mainly because of being referred to as the 'grandfather' clause, a legal and an accurate term. Do note, these changes come into effect only starting 1st April 2018. We'll see how it impacts your decisions below.


How does it affect your portfolio? - There are a couple of ways this impacts your portfolio. We'll start off with some of the straightaway implications, moving on later to the more contentious ones down the ladder.


1. More reason to avoid Dividend schemes of Equity funds – Fund houses will now have to pay a dividend distribution tax (DDT) of 10% for Equity oriented schemes from 1st April 2018. At Expowealth, we have always held the view that Dividend schemes do not provide many benefits as compared to growth schemes. Now, dividend schemes actually have a negative impact compared to growth schemes!! Avoid them completely.


2. SIPs needed for goal planning just shot up – Since the 10% LTCG tax now has to be taken in account for determining the expected value of the investment at the time of redemption, the SIP contribution for equity schemes required to reach the goal just shot up by 10% (ignoring the 1L deduction). 


3. Friction to rebalancing decisions – One of the unintended by-products of FM’s decision to gather tax on LTCG is the immense complexity it adds to rebalancing decisions for individuals as well as advisors. 

  • Switching to direct schemes – If you intend to switch to Direct schemes, make sure you do so on or before 31st March 2018 OR as long as the NAV of your scheme is less than that as of 31st Jan 2018 (but not too less) to avoid any LTCG on switching.
  • Rebalancing equity portfolio – With the STCG rate at 15% and LTCG rate at 10% (with 1L benefit), the decision to rebalance got slightly easier while also slightly complex. Easier because the gap between the two rates has narrowed and hence the importance of tax consideration on rebalancing reduces. However, what that impact is and how to take that into account is now much more complex due to the 1 lakh deduction applicable on LTCG.

4. Other schemes to be relatively more attractive - Many other investment products, which now have better tax treatment (or relatively less bad treatment), now get even more attractive.

  • NPS (National Pension Scheme)– The argument for NPS for retirement planning, which has only 40% corpus tax-free, got slightly stronger due to equity MFs becoming relatively less attractive. 
  • Thematic portfolio investing / PMS – These guys just got a bit complex due to friction for them to rebalance just as we described in an earlier point. Plus, the LTCG tax directly impacts the revenue of the PMS service provider.
  • The ELSS vs ULIPS vs PPF argument – While we’ve always been against ULIPS - The fundamental problem with ULIPs, ELSS and ULIPs, both, got relatively less attractive to PPF due to the 10% LTCG tax, which is not the case with PPF.


5. Opportunity for financial engineering – The Budget gives leeway to the investor, in that there’s a 1L deduction for LTCG every year. This makes things very interesting. There is now an opportunity to churn the portfolio and book LTCG up to 1 lakh every year, thus reducing taxes payable at a later date. Read our detailed article for the same.


6. Not much of an Arbitrage (schemes) -  This in our opinion is a direct casualty of the introduction of LTCG on equity schemes. For many years, the selling pitch of arbitrage scheme has been "get liquid/money-market returns with zero tax after 1 year". This changes significantly now. To understand the impact this causes to arbitrage schemes, read our detailed article here. The summary of the effect on arbitrage schemes being:

  • If you intend to use proceeds from arbitrage schemes in less than 3 years, they still make sense from a tax point of view. But note, these are not the same as liquid schemes. Read more about Arbitrate schemes.
  • If you are a high net-worth individual investing in these schemes for a longer horizon, we’d suggest staying away from these schemes. The benefit of indexation in liquid/money market funds will compound over a period of time to give significant benefits in the long run. I highly suggest you go through our detailed article here.


We hope we have been able to add value to our investors to understand the impact of the Budget on your investment better. Feel free to reach out to us for any suggestions/queries.


Happy Investing!


P.S: Look here for a detailed version of the same article