Budget 2024: Tax alterations affecting stock markets — capital gains tax, STT on F&O, and more

Up until 12.15 pm on July 23, the Indian benchmark index BSE Sensex was trading flat, as investors soaked in the the Union Budget 2024 announcements and altered positions on various sectors carefully. However, things changed fast post-noon, and within 15 minutes, the index nosedived sharply by almost 1000 points. So, what spooked investors and how will these proposed changes impact your portfolio returns? Read on!

Increased capital gains tax

The major reason behind the sharp fall was the finance minister Nirmala Sitharaman's proposed several changes in the capital gains taxation regime. The FM announced an increase in short-term capital gains (STCG) rates on certain assets to 20% from 15%. Additionally, long-term capital gains (LTCG) on certain specified assets will now be taxed at 12.5% from 10%.

To soften the blow, she announced a hike in the LTCG exemption limit to Rs 1.25 lakh per year. Unlisted bonds and debt mutual funds will continue to be taxed at the applicable rate.

“While the increase in capital gains exemption from ₹1 lakhs to ₹1.25 lakhs will encourage the middle class to invest more in equities, mutual funds, and other linked products, an increase in long-term capital gains tax to 12.5% will have a significant impact on HNIs' decision process of investing in alternative asset classes where money is typically tied in for 4-5 years,” says Ms Pearl Agarwal, Founder and Managing Partner, Eximius Ventures.

For the unversed, stocks held for less than a year are classified as short-term, and shares held for more than 12 months are termed long-term. Similarly, different asset classes carried different holding periods to be classified as either.

Now, according to the Memorandum of the Finance Bill 2024, the finance minister intends to rationalise and simplify the capital gains taxation with a three-pronged approach. The Memorandum proposed that there will only be two holding periods for differentiating between long- and short-term: For all listed securities, the holding period is proposed to be 12 months, and for all other assets, it shall be 24 months.

Thus units of listed business trust will now be at par with listed equity shares at 12 months instead of earlier 36 months. The holding period for bonds, debentures, gold, unlisted shares and immovable property will reduce from 36 months to 24 months. This reclassification is also expected to benefit investors as more and more assets with much shorter holding periods will be classified as long-term.

Increased tax on Futures and Options (F&O) transactions

The government came down hard on the equity derivatives segment or the Futures and Options (F&O) as it increased the Securities Transaction Tax (STT).

According to the FM speech, "It is proposed to increase the rates of STT on sale of an option in securities from 0.0625 per cent to 0.1 per cent of the option premium, and on sale of a futures in securities from 0.0125 per cent to 0.02 per cent of the price at which such futures are traded."

The move was largely in the expected lines, amid the unprecedented spike in futures and options (F&O) trading across India. The government has often tried to curtail speculative trading with higher taxes to discourage retail investors from losing money similar to previous instances of higher taxes on income from lottery or cryptocurrencies. India's monthly F&O turnover has risen dramatically to a record Rs 8,740 lakh crore (or $1.1 trillion) in March 2024 compared to a mere Rs 217 lakh crore (approximately $ 27 billion) in March 2019, accounting for over 80% of such trades in the world.

However, market experts do not expect a major change in the net impact due to the recent drop in exchange turnover charges. "While STT has been increased on both Futures and Options from 1st October 2024, this is the same date when exchange turnover charges will be reduced. In my view the net impact of this will be largely net neutral for the customer. Example, STT on Options will increase by ₹3.75 per ₹10,000 round trip premium turnover while exchange turnover charges should reduce by approx ₹3.50 to ₹4," says Ashish Nanda, President and Head - Digital Business, Kotak Securities.

To summarize, the proposed changes aim to streamline and simplify the capital gains taxation system by reducing the holding periods and adjusting the tax rates. The amendments will affect various financial instruments differently, with long-term capital gains on listed equity shares, equity-oriented funds, and business trusts seeing new exemption limits, while unlisted bonds and debt instruments will be subject to the regular applicable tax rates without indexation benefits.

(With inputs from agencies)