Jaitley’s LTCG tax targets savings of the middle class

In the end, Long-Term Capital Gains tax (LTCG) might end up being ironic. The Finance Minister had expected to earn an extra Rs 20,000 crore from the LTCG on the back of a 30 per cent rise in the markets in the year preceding the budget. The Sensex has, however, lost more than 6.5 per cent since his budget speech, reducing the government’s earning prospects from the tax.

While the move may not be much help for the Finance Minister, it has left a series of unanswered questions, making LTCG one of the many policy initiatives in which the rule book is rewritten almost on a daily basis. The financial services industry is left wondering why the government had to bring back the tax 14 years after it was disbanded?

It has been almost three weeks since the tax was announced, and though the government brought in FAQs to clear the air, some ambi-guities and doubts remain. It is not clear if the LTCG tax would be applicable on shares inherited after January 31, 2018, when the period of ‘grandfathering’ ended.

It is also not clear if the mergers and demergers will be covered under the ‘grandfathering’, and this becomes important because 22 major proceedings may be impacted by changes in the policy framework — this includes the IDFC Bank-Capital First merger. Besides, the tax would also impact the promotors in cases where IPOs have been announced and there are fears that they may have to pay LTCG on acquisition cost.

The government’s decision to include mutual funds which hold more than 65 per cent of their assets in equities, however, has added to the complexity for the middle class who may now be forced to read the financial fine-print in much greater detail. With an effective rate of taxation at 10.4 per cent, the tax has practically become a tax on savings and retirement funds of the middle-class.

The Finance Minister, who has spent the last four years fighting mostly Modi-made crises and then a few of his own, finds himself at the end of the line. At the end of four years, the much promised ‘take-off ’ has not happened and he is struggling with serious financial problems with close to 32 per cent of the budgetary resources going into servicing debts, pushing the government to cut spending on schemes where financial allocations are made.

He has been forced to suspend following the ‘glide-path’ for fiscal consolidation for political reasons, but needs every rupee he can get from taxation. With revenues adding to Rs 16.23 lakh crore and expenditure at Rs 22.17 lakh crore, a shortfall of Rs 5.94 lakh crore translates to a gap of 36.5 per cent.

The Finance Minister would have looked to tax the stock market as an additional source of revenue as the markets have seen a significant rise over the last year. The Sensex stood at 27,656 points at the end of January 2017, which went up to 36,033 points at the end of January 2018, a rise of 8,377 points, or 30%. The Finance Minister and his team saw the markets as a space that could make up for the revenue shortfall in other sectors.

The Finance Minister was quoted as saying, “The return on investment in equity is already quite attractive even without tax exemption. There is therefore a strong case for bringing long-term capital ains from listed equities in the tax net.” Mr Jaitley, however, forgot one basic rule— capital gains come mainly when the markets go up, there is very little money to be made when the markets go down.

The markets have been on a downslide through most of February, first starting with a global correction and then followed by the PNB crisis. The net result has been the Sensex losing 2,330 points or 6.5% from its pre-budget highs. Nothing on the economic horizon suggests that we are going to see either a 30% rise in the stock market or a dramatic turn-around in corporate profits, which have been on the decline for the last three quarters.

The lack of resources is visible in how the government is pulling back expenditures on schemes like Smart Cities, which were supposed to transform the urban areas. A total of Rs 49,500 crore was sanctioned for the projects but only Rs 9,863 crore was released and of this only Rs 720 crore was actually spent, making the scheme a complete non-starter.

All eyes are on the global crude prices now, which continue to offer some fiscal room to the government. Crude had crossed the $70 per barrel mark in late January 2018 but has slid back to $65 per barrel as of now. If crude prices rise beyond $70, government finances may face additional stress as the government would not want petrol prices to go beyond Rs 75 per litre in Delhi, forcing them to cut excise rates.

As the Modi government enters election year, it seems not only short of achievements but also short of fiscal room to implement some ‘out of the box ideas’ that could improve its political prospects ahead of the elections. It seems Jaitley and his team would go down in history as people who gloriously overpromised but disastrously under-delivered.