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For a change, let's 'un-speculate' on taxes!

Don't tweak your investments on the basis of rumours before the budget in order to avoid taxes

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to /tax/

This year, the pre-budget speculation is much stronger than usual. Of course, a mild increase in the tax slab cut-offs is always conjectured and at times translates into reality. However, things are different this year. GST and demonetisation have driven home the idea that this government will not shy away from big, groundbreaking changes. Indeed, there's now no shortage of media stories that use words like 'blockbuster' to pre-announce what their sources tell them is coming in the budget.

At first glance, such tax changes appear to raise some interesting implications for savers and investors. However, a lot of savers may not take any action in lieu of these rumours.

Of course, I must issue a disclaimer upfront: by commenting on these changes, I am definitely not predicting that they will actually happen. The Narendra Modi government has mastered the art of holding its cards close to its chest. We have ample proof of it in the past. A little tweak in slabs or rates aside, if there are some groundbreaking changes in the structure of personal income tax or capital gains tax, then it is more likely that the purported leaks were actually just wild guesses.

There's a great deal of speculation that the number of tax slabs will be increased by creating an additional slab just above the lowest one, perhaps from Rs 5 lakh to Rs 7.5 lakh. Last year, when the budget was presented just after demonetisation, the tax on the lowest slab was dropped from 10 per cent to 5 per cent, leading to a big cut in the tax outgo of earnings which are less than Rs 5 lakh a year. The logic of an additional slab is that there is a huge jump from 5 per cent to 20 per cent after Rs 5 lakh. This is undoubtedly true. Someone with a taxable income of Rs 5 lakh paid Rs 12,875 this year, while someone with Rs 5.6 lakh paid double the amount. So the first Rs 60,000 of income after Rs 5 lakh has as much tax outgo as the initial Rs 5 lakh. That feels extremely unfair to people who belong to this slab, and it probably is!

Apart from personal income tax, the other big rumour is that of the reimposition of long-term capital gains tax on equity investments. I first wrote about this almost a month ago. As I had pointed out, such a tax would not be surprising at all, given that the Prime Minister himself has said that he considers zero tax on financial income to be unfair. There are two ways of reimposing such a tax. Currently, all capital gains on listed stocks and mutual funds have zero tax imposed on them, if the investment is held for more than a year. Clearly, there are two distinct ways of changing this. Either the 'zero' has to increase, or the 'one year' has to increase. Or perhaps both?

Investors and advisors who are pre-empting the increased taxation are advocating a strategy of selling off all equity-based investments that have been held for over a year and immediately repurchasing them. The logic is obvious--it resets the clock as far the holding period goes. The returns part of the sale proceeds will be tax free and will thus get protected from any tax that Mr Jaitley introduces on February 1. Of course, if such a tax is actually announced on February 1, and is applicable from April 1, then there could be a lot of chaos and it's hard to imagine Mr Jaitley not anticipating it. Could the period be raised to three years then? That's the likeliest route, and one where any attempt at mitigation would actually run counter to what you would do in the above case.

The best thing to do is pretty obvious, which is nothing. Taking high-impact and precipitous actions based on what could end up as just routine fiction from 'sources' is really not the wisest thing to do. Even if these guesses are vaguely correct, the actual implementation could be done in the way that any action one takes now could be counter-productive. The best thing to do is to treat investments as investments only, stick to your financial plan, and not buy and sell investments based on conjectured changes in taxation.

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to /tax/

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