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The taxman may end up being a speed bump for the Indian stock market, which like its counterparts across the world has marched to multiple records in the past year.
Brokerages including Kotak Securities say Prime Minister Narendra Modi's administration may make it harder for investors to claim exemptions on capital gains from equity investments when the federal Budget is announced on February 1. Modi's move in 2016 to scrap high-value currency bills and the implementation of the new sales tax last July have hurt demand and revenue, forcing the government to borrow more.
"The government has to find avenues for generating additional revenue to bridge the fiscal deficit," Shefali Goradia, partner at Deloitte Touche Tohmatsu India LLP, said in an interview in Mumbai. "Tweaking the long-term capital gain break is a low hanging fruit."
Even so, the government may shy away from doing so -- any change may spook individual investors, who've flocked to mutual funds since Modi swept into power in 2014. The main S&P BSE Sensex soared 28 per cent last year, beating the S&P 500's 19 per cent advance, as domestic funds bought a record $19 billion of shares -- more than double the inflow from overseas. The cash ban helped accelerate the shift to financial assets, taking the sheen off gold and property.
Assets with money managers reached a record Rs 23 trillion ($351 billion) in December, with equity plans making up 38 per cent of the pie, data from the Association of Mutual Funds in India show.
"Long-term capital gains tax break has led to better participation in equity markets," said Nilesh Shah, Chief Executive Officer at Kotak Mahindra Asset Management Co, which has $19 billion in stocks and bonds. "And it is not that this participation comes for free. Investors pay a securities transaction tax."
And sceptics point out that seemingly every Budget brings talk of the return of the levy, which was replaced by a transaction cost -- applicable when stocks are bought and sold -- in 2004. A remark in December 2016 by Modi that people who profit from equities should pay more taxes unsettled investors, prompting Finance Minister Arun Jaitley to clarify then that the government had no such plans. Finance Ministry spokesman D S Malik declined to comment.
"The debate starts before the event each time and everyone gets sensitised to it," Hiren Ved, chief investment officer at Mumbai-based Alchemy Investment Management Ltd, told Bloomberg Quint. The tax is "low-probability event" as the government may not want to "disturb the apple cart" given its on-going asset-sale programme, he said.
Kotak Securities says the administration may remove the tax break on stock investments held for more than one year or raise the holding period to claim long-term tax exemption to three years from one. The STT, which brought in about Rs 80 billion last financial year, is just one-tenth of what long-term capital gains tax can potentially earn, Deloitte's Goradia said. Incremental collections could rise by $5 billion to $10 billion per year if the exemption is taken away, according to CLSA India Pvt.
The government may chose to extend the holding period, while maintaining the rate at zero, said Sampath Reddy, chief investment officer at Bajaj Allianz Life Insurance Co.
"This may not hurt sentiment in a buoyant market and we believe investors can easily digest this," he said.