Investors should minimise amount of profits to avoid capital gains tax

Whether they invest through funds or directly, the zero rate of capital gains tax is a great comfort for long-term equity investors in India. Many investors are sitting on substantial gains they have made over the years, and the fact that they will be able to redeem these without paying capital gains tax is a huge plus point.

However, if one reads the straws in the wind, there's a possibility that eventually, this happy state of affairs may come to an end, and that too in a pretty messy manner. Firstly, given the fiscal situation of the government there is no guarantee that long-term capital gains tax will forever be zero. At some point we could see such a tax re-imposed.

While that would be a disappointment, the posture that the finance ministry has taken regarding GAAR (General Anti Avoidance Rule) points to a huge hidden problem in a potential re-imposition of capital gains tax. Logically, if the government were to re-impose such a tax, it should not be applicable to transactions that commenced (and gains that were made) at the time when the tax doesn't exist, even if such gains were realised after the tax comes into being. Such an exemption for older transaction is called "grandfathering".

In the case of GAAR, the finance ministry appears to have rejected grandfathering. Therefore it is logical to assume that when capital gains tax is re-imposed, then older investments will also come into the fold.

I admit that all this is yet in the realm of speculation, but a simple extrapolation of current trends indicates that it could eventually happen. There's one simple thing that investors can do is to minimise the amount of gains that they are holding. For example, if there's a mutual fund investment you made a decade ago, you could just redeem and immediately reinvest it, a round-trip that will save you from potential tax. Of course, if the tax was actually re-imposed, then in the ensuing panic many of these round-trips would become half-trips.

 

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