Tough ride ahead

TAXING TIMES

With the hike in the short-term capital gains tax, high net worth individuals have to rethink their trading strategies

The recent Union Budget has delivered a nasty surprise for both the equity and commodity markets, in terms of increased costs for investors and, especially the ones who aggressively play the market.

By increasing the short-term capital gains tax from 10 per cent to 15 per cent, the finance minister has clearly given the signal that long-term investors are being encouraged.

Of course, the timing of this move could not be worse. The Indian stock markets have already been under pressure because of fears of recession in the global market. And the rise in taxation will only make matters worse. Especially for high net worth individuals (HNIs), who trade in the markets regularly, it's the time to look for other options.

However, before looking at the strategies that HNIs can use, let's look at the securities transaction tax (STT). Introduced in 2004, this tax was imposed on all trades in the equity markets.

The idea was that instead of taxing the gains, the trades were taxed, in order to increase tax collections through better tax compliance as well as to encourage more delivery-based trading.

Also, the idea was reduce tax leakages as the exchanges were responsible for collection and payment of these taxes on all trades.

Typically, the STT would work in this way. For instance, if a high net worth investor bought or sold for delivery on the NSE, a brokerage of say 0.1 per cent or Rs 10,000 per crore would be charged.

Then, there would be other charges such as exchange transaction cost, state government stamp duty and service. All this charges would add up to around Rs 15,000. In all, there would be Rs 25,000 being charged on a transaction of Rs 1 crore.

However, in the new tax regime, the short-term capital gains (STCG) has been raised to from 10 per cent to 15 per cent.

There is more to it as well. If you are an investor, who doubles up as a trader, you will find that the STT paid, which was earlier treated as a rebate, is now being treated as a deductible expense.

In other words, this means that earlier, one could reduce the amount of STT already paid from one's tax liability on trading profits. Now, this will be treated as anexpense.

That is, earlier when you earned Rs 100 in trading and paid an STT of Rs 20, the total tax liability on the Rs 100 gains was Rs 30. The tax liability, post payment of STT would be an additional Rs 10.

Post Union Budget 2008-09, the Rs 20 STT would be deducted from the gain of Rs 100. And the remainder of Rs 80 would be taxed and you would have to pay around Rs 24, if you are in the highest income bracket. Obviously, for HNIs, who use trading as a part of their investment strategy, this is not great news.

The big question, therefore is what should the HNIs be doing? A few market tips for survival in these tough times

Shift your investment horizon to long-term. Avoid the temptation of taking short-term calls in the market.

Avoid active churning of your portfolio to reduce the cost of brokerage, STT and other levies, which can eat into your margins. Select fundamentally sound stocks in your portfolio with a buy-and hold-strategy.

Have a greater bias towards quality large-cap and actively traded midcap stocks in your portfolio, since many thinly-traded small-and mid-cap stocks may become more illiquid and volatile.

Opt for a mutual fund, where you can get the best of both worlds while the fund manager actively manages the fund on a short-term basis, you get tax-free long-term capital gains. Times are not great for traders. And add to that volatile markets and things do look rather sad.

The writer is director, Touchstone Wealth Planners