Mind the taxes before you make long-term equity investments
Until a few years back, putting money into equity or shares was one of the most straightforward methods of investment among all asset classes. The dividend income in the hands of investors was tax-free and there was no long-term capital gains (LTCG) tax either. This meant that if you held any shares for more than a year then any income or capital gains arising out of it was tax-free.
In comparison, interest income from bank fixed deposits was taxable much like the rental income from house property. The sale and purchase of real estate and gold also attracted capital gains tax. This had made long-term equity one of the most tax efficient and no-nonsense investment assets for investors.
Investment in stocks and equity mutual funds for more than a year required little or no documentation or follow-up for tax purposes. This also meant a much superior returns on post-tax basis compared to other asset classes.
This is no more the case and the tax burden for equity investors has increased many fold in recent years.
A back of the envelope calculation suggests that all the taxes applicable on equities will now eat-up around 15 percent of the gross returns that the investors can hope to make over the long-term including dividend income.
So, a gross return of 10 per cent in a year would translate into post-tax returns of around 8.5 per cent. Here are the taxes you should keep in mind before long-term equity investments:
1. In 2018, the union budget introduced LTCG tax on equity investments. Before that, in 2016, the then Finance Minister Arun Jaitley had brought in a new 10 percent dividend tax payable on dividend income above Rs 10 lakh. The threshold was high and largely affected high-net worth investors (HNIs) and company owners, promoters and senior executives holding large amounts of stock options.
Having tasted success, the Finance Minister Nirmala Sitharaman abolished this Rs 10 lakh threshold and made the entire dividend income taxable in the hands of shareholders as per the tax rate applicable to their income.
Many argued that the new tax regime was more efficient because earlier, companies used to pay a flat Dividend Distribution Tax (DDT) of around 20 percent while most retail investors would now pay a much lower tax on their dividend income. But what about the hassle and paperwork involved in adding-up all the gains on equity investments made during the year and then working out the income tax on them?
Dividend tax is also applicable on dividend income from investment in equity mutual funds units. Besides, MFs have been instructed to deduct dividend tax on source if the dividend income is over and above Rs5,000 per annum.
2. The latest tax to be levied on equity investors is 0.01 percent Tax Collected at Source (TCS) for all securities transactions if the total value exceeds Rs 50 lakh. Right now, there is some ambiguity on these taxes and brokerages are not collecting this tax but it has hit high frequency stock traders and large investors.
3. All these recently-introduced taxes on equity are over and above the short-term capital gains tax of 15 percent on stocks or equity mutual funds held for less than a year.
4. Equity investors also pay a security transaction tax or STT at the rate of 0.1 per cent or 10 paise for every Rs 100 worth of delivery-based sale and purchase of shares on the market. STT is 0.017 percent in case of options and 0.01 percent on sale of futures
Obviously, the government and the tax department think that equity is a very lucrative asset class and that investors are raking-in big money in the market. In reality, however, all these taxes have come at a time when both capital returns and dividend income from equity has been falling.
The benchmark Nifty 50 index is up only 17 percent cumulatively in the last three years, translating into an unimpressive annualised returns of 5.6 percent, just about enough to cover inflation and even lower than the yield on fixed deposits.
5. The five-year returns on Nifty 50 index works out to around 7.6 percent on an annualised basis. And mind you, these are pre-tax returns and don't take into account transaction costs such as STT and brokerage fee. After the recent tax changes the post-tax return would be even lower.
The growth in dividend income has been equally tepid for long-term equity investors. The dividend pay-out by the listed companies has grown at an annualised rate of just 3.8 percent in the last three years and only 6.8 percent in the last five years. This is not surprising given poor growth on corporate earnings during the period.
6. The tax incidence on equity has grown at a faster clip in the last five years than the headline returns given by the asset. So next time you jump head-on into equity thinking it is a classic long-term asset, think of all the taxes that are now levied on it and how it will impact your post-tax returns.
In equity, now think of post-tax returns and discount the headline pre-tax returns so often quoted by media, brokerages and the mutual fund executives. Think twice before equity investment now. And the total tax incidence could be as high as 20 percent for investors in the top income tax bracket.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
/30-stades/media/agency_attachments/C8R8KLQ6iqxfzqUhMFYv.png)
Follow Us/30-stades/media/post_banners/HiMJWX23OkihjZh1N1Bx.jpg)
/30-stades/media/post_attachments/8RH0MJ5VffVGRJnaVgnH.jpg "publive-image")