The Budget's tax changes aim to curb speculative trading and align with economic conditions but have temporarily dampened market sentiment due to policy stability concerns
This essay is part of the series "Budget 2024-25"
The Budget's tax changes aim to curb speculative trading and align with economic conditions but have temporarily dampened market sentiment due to policy stability concerns
On 23 July, Finance Minister Nirmala Sitharaman unveiled the Union Budget for 2024, marking her seventh consecutive presentation and the first under Prime Minister Narendra Modi’s newly re-elected administration. The Budget emphasises targeted support for critical sectors, including the economically disadvantaged, women, and farmers.
India Inc. is anticipating a range of measures aimed at stimulating consumption, including potential reforms in taxation, GST exemptions, and enhancements to the PLI scheme. However, one of the focus areas of this Budget was on fiscal prudence. The government has adopted a realistic approach with revenue and expenditure forecasts, avoiding populist measures in favour of a pragmatic and sustainable fiscal strategy. This perhaps reflects a commitment to long-term economic stability rather than short-term gains, aligning with broader macroeconomic objectives. The increase in the standard deduction and redefinition of the tax slabs are slated to increase households' disposable income.
In the Budget 2024, the Finance Minister announced a significant hike in the Securities Transaction Tax (STT) rates for equity and index trades, raising the rates from 0.01 percent to 0.02 percent, attempting to deepen the tax base. The STT on futures and options (F&O) is proposed to be increased to 0.02 percent and 0.1 percent, respectively. This amendment will take effect from 1 October 2024.
The STT is a mandatory charge applied as a percentage of the transaction value, introduced in the 2004 Budget and implemented in October of the same year. The STT aims to reduce tax evasion by taxing transactions at the source and applies to stocks, futures, options, mutual funds, and exchange-traded funds. For transactions to qualify for the long-term capital gain exemption, the asset in question must be subject to STT. This tax applies to all transactions occurring on exchanges. Sitharaman's decision to increase the STT is likely driven by an objective to curb excessive speculation in the F&O markets. Her announcement followed the economic survey's concerns over the rising interest of retail investors in derivative trading. The survey, providing an overview of the economy, highlighted that speculative trade holds no beneficial place in a developing country like India.
By increasing the STT, the government aims to moderate speculative trading activities, ensuring a more stable and less volatile market. This move is part of a broader strategy to deepen the tax base while promoting responsible investment behaviours among market participants.
The Finance Minister also announced changes to capital gains tax rates and holding periods, impacting both long-term and short-term capital gains. The long-term capital gains tax (LTCG) on all financial and non-financial assets has been increased from 10 percent to 12.5 percent. Meanwhile, the short-term capital gains tax (STCG) on certain assets will rise to 20 percent. Additionally, the exemption limit for long-term capital gains has been raised from INR 1 lakh to INR 1.25 lakh per year.
The long-term capital gains tax (LTCG) on all financial and non-financial assets has been increased from 10 percent to 12.5 percent. Meanwhile, the short-term capital gains tax (STCG) on certain assets will rise to 20 percent.
The Budget introduces new classifications for assets: listed financial assets held for more than one year will be deemed long-term, while unlisted financial assets and non-financial assets must be held for at least two years to qualify as long-term. Unlisted bonds, debentures, debt mutual funds, and market-linked debentures will be taxed at applicable rates regardless of the holding period. The table below highlights the changes in LTCG and STCG.
|
Type of asset |
Holding period for LTCG |
Holding period for STCG |
|
Listed Equity Shares |
More than 12 months |
12 months or less |
|
Equity-Oriented Mutual Fund Units |
More than 12 months |
12 months or less |
|
Unlisted Equity Shares (Including Foreign Shares) |
More than 24 months |
24 months or less |
|
Immovable Assets (House, Land, Building) |
More than 24 months |
24 months or less |
|
Movable Assets (Gold, Silver) |
More than 36 months |
36 months or less |
One underlying rationale for these changes is the aim to rationalise the capital gains tax structure while addressing inflationary adjustments through the elimination of the indexation benefit for property sales. The proposed modifications are anticipated to yield an additional INR 15,000 crore in revenue. These changes reflect the government's strategic approach to aligning tax policies with evolving economic conditions and shifting investment behaviours, thereby ensuring a more robust and adaptive fiscal framework.
The substantial increase in the STCG from 15 percent to 20 percent appears largely justified, especially given the escalating concerns about the overheating derivatives market. Recent analyses highlighting the shift in trading volumes indicate a clear signal of the government’s strategic intent to moderate activity within the derivatives sector. This is underscored by insights from the Economic Survey 2024, which equated derivatives trading with gambling and criticised market practices that resemble leveraged bets, often disguised as financial innovations from developed countries. The survey argues that such speculative activities are unsuitable for a developing nation with a low per-capita income.
The substantial increase in the STCG from 15 percent to 20 percent appears largely justified, especially given the escalating concerns about the overheating derivatives market.
In a way, the Budget appears to have addressed several significant challenges with the revision of the LTCG. For example, for serious long-term investors, the increase from 10 percent to 12.5 percent is a minor adjustment in the broader context of their gains. The basic exemption limit for LTCG on equity-oriented investments has been increased from INR 1 lakh to INR 1.25 lakh per year. Therefore, if an investor holds a listed financial asset for over a year and realises a gain of less than INR 1.25 lakh, no tax liability will be incurred. However, for unlisted financial assets, the investment must be held for a minimum of two years to qualify for LTCG treatment. This adjustment aims to provide greater tax relief to investors while encouraging longer-term holdings in the financial markets. This policy shift could therefore be seen as a way to promote genuine stakeholder engagement in India's economic growth narrative. While the LTCG hike might temporarily dampen market sentiment, it is likely that capital market participants will adapt to this adjustment and continue their investment activities.
The removal of the indexation benefit for property sales signifies a major shift in real estate taxation. Property owners can no longer adjust their purchase price for inflation, leading to increased capital gains and thus higher tax liabilities. This change, aimed at simplifying and rationalising the tax regime, might deter investors from assets subject to higher taxation. Despite the reduction in the LTCG tax rate to 12.5 percent, the loss of the indexation benefit is largely negative for those planning to sell older properties, as it ultimately reduces profitability from real estate transactions.
The recent Budget’s capital gains tax revisions have eclipsed other fiscal measures, with the hikes in both short-term and long-term capital gains tax rates expected to raise the hurdle rate for financial assets. This shift is likely to dampen market sentiment, as it reflects investor unease over the stability of tax policy and fears of potential future increases. However, a case can be made for growth in the medium and long term for investors with a long investment horizon.
Prior to the announcement, the financial markets had been buoyant, reflecting a period of optimism. However, the immediate post-announcement reaction has been one of cooling, with benchmark indices closing slightly lower. On 23 July, the Sensex dropped to 80,024, while the Nifty dropped to 24,225, despite recovering from intraday lows.
Prior to the announcement, the financial markets had been buoyant, reflecting a period of optimism. However, the immediate post-announcement reaction has been one of cooling, with benchmark indices closing slightly lower.
These tax changes are set against a backdrop of significant retail investment in financial markets in recent years. The adjustments, projected to generate an additional INR 15,000 crore, are poised to significantly influence investor sentiment. While the market may currently be experiencing a period of adjustment, attention is anticipated to shift back to corporate earnings and the underlying strength of the Indian economy as the initial reactions to these tax revisions stabilise.
After the Budget presentation, Prime Minister Narendra Modi described it as aimed at empowering the rising middle class. Although the market is currently in a phase of adjustment, it will be crucial to observe public sentiment and market responses over the coming weeks to assess the Budget's actual impact and effectiveness.
Sauradeep Bag is an Associate Fellow at the Observer Research Foundation.
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Sauradeep is an Associate Fellow at the Centre for Security, Strategy, and Technology at the Observer Research Foundation. His experience spans the startup ecosystem, impact ...
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