Union Budget 2025: Is a potential increase in capital gains tax cause for concern among investors?
Union Budget 2025: The increase in capital gains tax announced in the last budget has caused concern among investors, who fear it may be the first of many hikes to come. The government raised the short-term capital gains tax on equity holdings held for less than one year from 15 percent to 20 percent, and the long-term capital gains tax on holdings sold after one year from 10 percent to 12.5 percent.
Ashish Gupta, Chief Investment Officer at Axis Mutual Fund, has warned that this increase could be just the beginning. “To my mind, this looks like a first step, as 12.5 percent is an unusual rate. I wouldn’t be surprised if it moves up to 15 percent by the next Budget,” Gupta remarked after Modi 3.0’s July Budget.
Despite these concerns, most market experts do not expect another hike in capital gains tax, especially in such a short period. According to Moneycontrol’s latest markets poll, nearly 90 percent of respondents believe the finance minister will not raise capital gains tax in the upcoming Budget.
The Moneycontrol Market Poll gathered responses from various market participants, including broking firms, mutual funds, AIF/PMS players, and independent analysts, receiving more than three dozen responses.
Despite the consensus, there is still a possibility of a surprise hike that cannot be completely ruled out. Such a move has the potential to disrupt the market, worsening concerns about slow earnings growth, economic slowdown, and expensive valuations. The increase in taxes could make equities less appealing to investors, possibly prompting a shift towards longer-term investments in debt instruments or other tax-efficient options.
While we do not anticipate a further hike in capital gains tax, any such action would negatively impact the sentiment of all types of investors. Rahul Jain, President and Head of Nuvama Wealth, stated that any tax hike would result in investors retaining less profit.
Any attempt to raise the capital gains tax would dampen sentiments in the short term and could lead to a decrease in fund flows from both institutional and retail investors who have been heavily investing in mutual funds, according to Jain.
The long-term effects of higher capital gains tax are significant. Market veteran Shankar Sharma recalled the imposition of long-term capital gains tax in 2018, which was followed by a period of underperformance by India compared to global markets.
In 2019, after the LTCG tax, India ranked as the 18th worst-performing market globally, with returns of only 6-7%, compared to 25-35% gains in other major markets like Europe, the S&P, and Nasdaq, as noted by Sharma.
Foreign institutional investors (FIIs) are particularly affected by such tax hikes, as seen in the difference between pre-tax and post-tax returns. Samir Arora, founder and fund manager of Helios Capital, emphasized that while Indian equities have performed well on a pre-tax basis, higher taxes could result in a permanent decrease in post-tax returns, potentially discouraging FII involvement.
Meanwhile, Sonam Srivastava, a fund manager at Wright Research, has raised concerns about the potential long-term impact of higher capital gains taxes. Srivastava believes that increasing taxes on short-term gains could discourage speculative trading, ultimately promoting a more stable and sustainable market growth.
However, Srivastava also acknowledges the risk of decreased participation from retail investors, which could negatively affect market depth and liquidity. A tax increase may also lead to lower trading volumes, particularly in the derivatives segment, as investors reevaluate their strategies due to higher transaction costs. This could result in reduced market liquidity, according to Srivastava.
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Disclaimer: This blog post is for informational purposes only and should not be considered financial advice. Investors should conduct thorough research and consult with a qualified financial advisor before making any investment decisions.