Eyeing Long-Term Gains

The pre-budget rally has been in line with the trend set in the last few years. The markets are expecting some positive triggers from the budget. But with inflation management expected to be on top of the FM’s mind, will the markets dance to his tunes?

• Short-term capital gains tax could be raised and long-term capital gains tax may come back in some form. Even the STT could be hiked. -Ramesh Damani, Member, BSE
• The budget should clearly define the transactions where the gains are treated as capital gains and where they are treated as business income. -Raamdeo Agrawal, Joint MD, Motilal Oswal Securities
• Looking at the budget and linking it to the markets, or for that matter any sector, have lost its relevance in an open and free economy.” - Parag Parikh, Chairman, Parag Parikh Financial Advisory Services

MUMBAI: A feeling gaining ground among a section of market players is that the budget these days is nothing but a formality. Any major changes that have a significant bearing on the country's stock markets are not necessarily announced in it. Rather, they are made as and when needed.

As Parag Parikh, chairman, Parag Parikh Financial Advisory Services, says, “The days of looking at the budget and linking it to the markets, or for that matter any sector, have lost its relevance in an open and free economy. The only thing constant, whether it's in the markets or elsewhere is the pain — and we have to have pain to reap the rewards.”

Having said that, the influence of the budget on the markets cannot be underplayed. Through significant inclusions or omissions it could tilt the balance either way. It might not affect market fundamentals, but it can surely sway investor sentiment. For instance, in seven of the last 10, there was a pre-budget rally that gave investors an average gain of at least 5.4% between January and February. This year, so far, the Sensex has climbed 5.45% since the last day of trading in December, 2006 — a pointer to investor expectations.

One issue on which the investing community is seeking clarity is the tax incidence on domestic investing entities. At present, the income tax department's assessing officer determines whether the gain accruing from stock market investments is business income or capital gains. If it is seen as business income, then such gains are added to one's other sources of income and taxed according to the bracket under which one falls. For someone in the 30% tax bracket, this would effectively work out to 33.66% (including surcharge and education cess).

If it's classified as capital gains, then one has to pay short-term capital gains tax of 10% for securities held for less than a year. But if the same is held for more than a year, no long-term capital gains tax is chargeable.

Marketmen also expect some changes in the structuring of the capital gains tax. "My sense is that this would be tinkered with. The Left would put pressure on the government to raise short-term capital gains tax. There is also a possibility of long-term capital gains tax coming back in some form,” says Ramesh Damani, member, BSE.
Even the securities transaction tax (STT), which is at 0.125% for cash market transactions (both on buy and sell sides), 0.017% for derivatives (only on sell side) and 0.25% for mutual funds (again only on sell side), is also likely to be raised.

“The decision on STT should take care of everything and should not leave any room for confusion. It should be structured in such a way that the incidence of tax on any stock market investment should be clear, including the ambiguity over how domestic traders’ income is taxed,” says Raamdeo Agrawal, joint managing director, Motilal Oswal Securities.

Many also expect a rationalisation of the corporate taxes. “There are strong rumours that the surcharge on corporate taxes would be cut,” says Agrawal. This would effectively bring down the corporate tax rate from 33.66% (inclusive of surcharge and education cess) to around 30%.

He also feels that indirect taxes like customs and excise duties would be brought down, which would again augur well for the overall sentiment in the markets.

Meanwhile, participatory notes, through which a significant amount of foreign investments comes into the equity markets, has long been on Sebi's radar as an area needing more regulatory vigilance. Though this may not fall under the budget's purview, anything that disturbs the current status, whether it happens pre-, post- or during the budget, is likely to have an impact on the markets.

“Any notification banning participatory notes or reducing tax exemptions given to foreign institutional investors as they exist now, will not be taken lightly by the markets,” says VK Sharma, director and head of research, Anagram Securities.