Markets will plunge if government tinkers with LTCG tax in Budget 2017. Here’s how

Indian stock market was quite upbeat since December about Budget 2017 but the happiness may be shortlived as few analysts are predicting possibilities of the government changing the long-term capital gains tax (LTCG) in the upcoming Union Budget 2017.

If the experts are to be believed, the benchmark equity indices are trading near key resistance levels and a bout of profit booking cannot be ruled out should the government decide to restructure the LTCG structure.

Currently, for a holding period of over 1 year, the long-term capital gains tax on equities is zero and the short-term capital gains tax continues to be at 15%. However, in context of other instruments such as debt mutual funds, the definition of holding period for computation of long-term capital gains tax has changed to three years, while for equities it has remained one year.

However, there has been a try by the Finance Minister, dispel fears regarding LTCG tax, analysts predict more probability that the holding period of equities could be changed from one year to maybe two or three.

According to the analyst who ET talked to, predicted these three scenarios:

Scenario 1:

This is the worst-case scenario as the government could enforce a five percent tax rate on LTCG while aligning the securities transaction tax (STT) and short-term capital gains tax with the income-tax slab.

Dalal Street won’t take it nicely and the benchmark indices could backfire. Some analysts see up to 10 % correction in the index in such a situation.

"This is a more likely to happen in this Budget. Initially, the market may react negatively, but it will ultimately be guided by other macro factors,” Pankaj Pandey, Head of Research, ICICI Securities, told ET.

The hope in the Dalal Street has already raised the Nifty50 to 8,600 level from 7,900 in December. The index is now facing resistance at 8,700 and requires fresh triggers to move higher. However, a five percent fall from the current level would bring down the index to about 8,100, which will lend initial support to the Nifty50. Also, a 10 % fall would take it to about 7,700 level, which would be more devastating for investors.

"There are murmurs of the long-term capital gains being altered. The market is not yet apprehensive enough. If the market remains at elevated levels till the Union Budget and there is some change in the long-term capital gains tax (LTCG) structure, we could clearly see a 5-10 per cent correction in the market, which would a sentiment dampener,” Nilesh Shah, MD & CEO, Envision Capital, told ET.

Scenario 2:

This is the base case scenario and according to the experts, the lock-in period could change from one year at present to two or three years, the securities transaction tax gets abolished and STCG remains unchanged at 15%.

Experts suggest that the STT is majorly killing the depth of capital markets by keeping the high-frequency traders away. The expectation from the government is to completely abolish STT to promote the equity culture in India.

"There is a 65 per cent probability that the lock-in period could change to either two or three years and STT could go away,” Harsha Upadhyaya, CIO - Equity, Kotak Mutual Fund, told ET.

"In that case, we could see some knee-jerk reaction, but volatility should ease soon. It will help inculcate a longer-term investment focus. There is a 35 per cent probability that everything remains status-quo, and in that case we could witness relief rally in the short term,” he told ET.

Scenario 3

This scenario can be the best-case scenario if there won’t be tinkering with LTCG and life will go on. The STT, too, will remain as it is and STCG will remain at 15%.

"If the best-case scenario materialises, expect a breakout, which could take the Nifty50 above the 9,000 level,” experts told ET.

"If the government refrains from tinkering with LTCG in this Budget and leaves the other two (STT and STCG) as they are, it will give a big push to the market. The Nifty50 will zoom past the 9,000 level,” Renjith RG, Associate Director at Geojit BNP Paribas, told ET.