The government has rolled out significant changes to the capital gains tax framework that are expected to impact a wide range of investors. Effective from 24 July, new tax rates on capital gains for various asset classes will be implemented. The key changes include an increase in STCG rates and LTCG rates, alongside the removal of indexation benefits across all asset classes. Here, we decode how different asset classes will be taxed under the new regime and what these changes mean for investors.

Why were Capital Gains Tax (STCG & LTCG) increased?

The increase in LTCG and STCG taxes signals a clear shift towards encouraging longer-term investments. By widening the gap between short-term and long-term gains, the government aims to foster a more stable and mature investment environment. Another point to note, is that the overarching theme of these changes to STCG & LTCG is simplification and rationalization of the tax code. By standardizing the LTCG tax rate at 12.5% and removing the differential treatment across asset classes, the new regime aims to make the tax system more straightforward. This simplification includes harmonizing the short-term and long-term capital gains definitions and tax rates across different investment vehicles.

Immediate Impact on Market Activity

The immediate reaction from the market and financial experts suggested a bearish outlook. The increase in taxes on both long-term and short-term gains is likely to deter retail investors and small traders, who have seen substantial growth in participation in recent years.

However, indices like the BSE Sensex and Nifty 50 soon recovered. This response mirrors previous instances, such as the post-election market dip on June 4, which quickly corrected itself.

The Economic Survey 2024 highlights that retail investors' share in the equity cash segment turnover was 35.9% in FY24, with demat accounts increasing significantly from 11.45 crore in FY23 to 15.14 crore in FY24. The current bull market in India, which has seen the stock market more than triple since the pandemic lows of April 2020, appears unshakable. Retail investors, now a major force in the market, have been pivotal in this growth. Buying the dip has become a widespread strategy among investors, reflecting a high level of confidence in the market's continued upward trajectory.

Changes in Investor Preferences

A survey by The Ken revealed that approximately 20% of respondents have experienced the "wealth effect," where their spending increased due to higher investment values. This trend signifies the emergence of a new, confident class of investors. With around 95 million unique investors in India, a threefold increase from 5 years ago, this group has a substantial impact on market dynamics.

A significant shift in investment preferences has been observed, particularly among younger investors. Fixed deposits (FDs), once a staple for conservative investors, are losing ground to equities and mutual funds. The survey highlights that more than 60% of respondents prefer equities over FDs, with younger age groups leading this shift. RBI’s concerns about this trend highlight the challenges banks face in attracting deposits amid the allure of high returns from equities.

Summary of Capital Gains Tax Changes For Listed & Unlisted Financial Products

The increase in the LTCG exemption limit offers some relief to small investors. If an investor makes gains of less than ₹1.25 lakh from listed financial assets held for over a year, they will not have to pay any tax on these gains. However, the removal of indexation benefits will negatively impact the tax efficiency of long-term investments, making it crucial for investors to reassess their strategies.

Impact of Capital Gains on Investors Investing in Stocks and Equity Mutual Funds

For stocks and equity mutual funds, the short-term capital gains tax rate has been increased from 15% to 20%. The long-term capital gains tax rate has also been increased from 10% to 12.5%. This shift aims to encourage long-term investing in equities, given the higher taxation on short-term capital gains.

Example of STCG & LTCG on Equities

Under the old tax regime, if an investor had invested ₹5,00,000 in equities or equity mutual funds and held them for 11 months, generating a gain of ₹50,000, the short-term capital gains (STCG) tax would be ₹7,500 at the rate of 15%, leaving a net gain of ₹42,500. In the new regime, the same gain would be taxed at 20%, resulting in a STCG tax of ₹10,000 and a net gain of ₹40,000.

For long-term investments held for over a year, the old regime taxed gains above ₹1,00,000 at 10%. For instance, on a gain of ₹1,50,000 after 13 months, the taxable amount would be ₹50,000, resulting in a tax of ₹5,000 and a net gain of ₹1,45,000. Under the new regime, the exemption limit increases to ₹1,25,000, meaning only ₹25,000 is taxable at 12.5%, resulting in a tax of ₹3,125 and a net gain of ₹1,46,875.

Changes to STT

The Security Transaction Tax (STT) on futures has been doubled from 0.01% to 0.02%, and the STT on options has been increased from 0.062% to 0.1%, effective from October 1. This increase in STT on F&O transactions is expected to particularly impact frequent traders, reducing their profitability and possibly leading to a decline in trading volumes. This aligns with the government's apparent objective of cooling down hyperactive trading activity in this segment.

Strategy for Equity Investments Going Forward

Given these changes in capital gains tax for investing directly in equities and equity mutual funds, investors should consider the following strategies:

• The Indian stock market is currently in a buy-on-dip type of market and significant opportunities still exist as we consider the impact of the Budget on specific sectors, upcoming interest rate cuts, macroeconomic changes etc.

• Focus on long-term investments to benefit from the higher LTCG exemption limit.

• Consider a diversified portfolio with a 60:20:20 allocation in large, mid, and small-cap equities, leveraging market dips for buying opportunities.

• For any international equities, maintain current exposure without significant changes, monitoring global market conditions.

Impact of Capital Gains on Investors Investing in Debt Mutual Funds

Definition of debt mutual funds is now any mutual fund that invests in more than 65% in money market instruments, debt etc. Now, from a taxation perspective, debt mutual funds will continue to be taxed at the slab rate of the investor, without any indexation benefits, regardless of the holding period. The mutual fund industry had hoped for a reversal of last year’s budget changes on debt funds that had removed these benefits.

Strategy for Debt Investments Going Forward

Given these changes in capital gains tax for investing directly in debt and debt mutual funds, investors should consider the following strategies:

• Increase exposure to debt instruments and adopt a barbell strategy, investing in both short-term and long-term bonds to manage interest rate risk.

• Focus on bonds with longer maturities to benefit from potential interest rate declines.

Impact of Capital Gains on Investors Investing in Real Estate

The removal of indexation benefits is likely to impact real estate investors significantly. Indexation had allowed investors to adjust their acquisition price according to inflation, thereby reducing their capital gains for taxation purposes. This change is likely to discourage long-term investments in real estate, pushing investors towards short-term holdings or alternative investment options.

Here is a calculation done by CLSA showing the difference for real estate gains across different holding periods & different returns.

Impact of Capital Gains on Investors Investing in Other Mutual Funds & Other Investments

The mutual fund industry welcomed the clarity in the latest budget for fund-of-funds and gold/silver ETFs. Changes in the previous budget had led to fund-of-funds and gold/silver ETFs being treated as debt funds for taxation purposes.

Hybrid Funds:

• Hybrid funds with at least 65% exposure to equity can now claim LTCG benefits after holding for over 24 months.

• Hybrid funds with 35-65% equity exposure will lose indexation benefits if held for more than three years.

Fund of Funds (FoFs):

• The tax treatment of FoFs is now clear: they are treated as equity or debt funds based on their underlying investments. FoFs investing primarily in equity funds can avail of LTCG benefits after a holding period of over 24 months.

Physical Gold, Gold Mutual Funds, ETFs, and Gold ETFs

Physical Gold, Gold Mutual Funds, ETFs, and Gold ETFs are now subject to the LTCG tax regime with a rate of 12.5%. Unlisted investments such as physical gold will now benefit from a long-term holding period after 2 years, reduced from 3 years under previous rules.

Strategy for Other Investments Going Forward

• Investors could maintain a modest position in gold as a hedge against inflation or market volatility, and consider buying when prices decline.

• The attractiveness of sovereign gold bonds might decline due to the uniform 12.5% tax rate on gold funds, reducing their relative tax advantage.

Impact of Budget on Power & Renewable Energy Sectors

Proposal:

• Setting up power plants and PPP in nuclear space.

• Formation of NTPC-BHEL JV for ultra-super critical thermal plants.

• Policy on pumped storage projects.

• Exemption on capital goods and critical minerals for renewable energy.

Impact:

• Increased energy availability and efficiency, especially in Eastern India.

• Enhanced indigenization and reduced reliance on foreign technology.

• PM Surya Ghar Muft Bijli Yojana will provide free electricity for end users up to 300 units per month.

• Improved energy storage and integration of renewable energy.

• Enhanced cost competitiveness for domestic renewable energy players

Recommendation:

Invest in the Power sector as itshows strong growth potential driven by new power projects and technological advancements. Renewable energy sector is set to benefit from significant government support and policy initiatives.

Impact of Budget on Infrastructure Sector (Transportation, Logistics & Digital and public infrastructure)

Proposal:

• Capital expenditure outlay of Rs.11.11 lakh crore (11% y-o-y growth)

• Long-term interest-free loans to state governments increased to Rs.1.5 trillion.

• Road connectivity projects costing Rs.26,000 crore

• Budget allocation for roads and railways at Rs.5.33 lakh crore (4% growth).

• Digitization of urban land records via GIS mapping.

• Industrial parks under PPP mode and National Industrial Corridor Development Programme.

• E-commerce hubs under a seamless regulatory and logistics framework.

Impact:

• Significant infrastructure development will drive demand for construction machinery and capital equipment.

• Enhanced infrastructure will support commercial vehicle (CV) demand.

• Positive outlook for the capital goods sector due to the boost in infrastructure projects.

• Modest growth in road infrastructure spending will stabilize the order books of road EPC companies.

• New project announcements under “Purvodaya” and industrial parks will drive order book growth and promote PPP.

• Enhanced first-mile and last-mile connectivity will improve cost-effectiveness of locally manufactured goods.

• Increased logistics efficiency and warehousing growth.

• Growth of data center infrastructure driven by DPI development and Digital India Mission.

• Improved revenue profile of Urban Local Bodies (ULB) through better property tax coverage.

Recommendation:

Invest in the logistics and warehousing sector as it is poised for significant growth due to infrastructure development and regulatory support.

Invest in the digital & public infrastructure as it is expected to benefit from the push towards digital infrastructure and urban development.

Invest selectively in the transportation infrastructure. Focus on companies with strong PPP involvement and those benefiting from new project announcements.

Impact of Budget on Capital Goods Sector

Proposal:

• Capital investment outlay of Rs.11.11 lakh crore (3.4% of GDP).

• Proposed outlay of Rs.10 lakh crore towards PM Awaas Yojana Urban Housing 2.0.

Impact:

• Boost in demand for capital equipment and construction machinery.

• Positive impact on companies involved in manufacturing and supplying capital goods.

Recommendation:

Invest. The sector stands to gain from increased capital outlay and infrastructure investments.

Impact of Budget on Financials, Banking, NBFC, Insurance Sectors

Proposals:

• Financial sector vision and strategy document.

• Enhanced credit schemes and Mudra loans for MSMEs.

• New MSME credit assessment models in PSBs.

• SIDBI expansion in MSME clusters.

• GST relief on co-insurance premiums.

• Rationalization of TDS rates on insurance commissions.

Impact:

• Proactive lending to MSMEs using digital footprints will bridge the significant credit gap (~Rs 28 lakh crore).

• Technology-driven underwriting skills in public sector banks will reduce delinquencies and formalize MSME credit.

• Enhanced Mudra loan limits align with inflation, providing MSMEs better access to funds for capital and working capital needs.

• Enhanced crop insurance penetration due to clear land details aiding assessment.

• Reduced compliance burdens and litigation for the insurance sector.

Recommendation:

Invest selectively in the Banking & NBFC sector. Focus on banks and NBFCs with strong digital capabilities and MSME lending portfolios.

Invest in the Insurance sectoras it is expected to benefit from regulatory simplifications and increased penetration.

Impact of Budget on Cement, Affordable Housing & Housing Finance Sector

Proposal:

• Rs.10 lakh crore for PM Awas Yojana 2.0.

• Reduction in stamp duty and rationalization of LTCG tax.

• Digitization of land records.

• Interest subsidies for affordable housing loans.

• Policies for rental housing markets.

• Construction of additional 3 crore houses in rural and urban areas under Pradhan Mantri Awas Yojana with Rs 2.2 lakh crore central assistance.

Impact:

• Significant boost in affordable housing demand, supported by large budget allocations and interest subsidies.

• Increased housing affordability with potential stamp duty reductions.

• Improved transparency with digitization of land records.

• Increased infrastructure, housing and urban development projects will drive higher demand for cement.

Recommendation:

Invest. The affordable housing sector is poised for growth with substantial government support and policy reforms. Housing finance companies will also benefit from increased demand for affordable housing loans. Cement sector is also expected to benefit significantly from the infrastructure and housing projects.

Impact of Budget on Electric Vehicles (EV) and Battery Manufacturing Sector

Proposal:

• Full exemption from customs duties on 25 critical minerals, including lithium, copper, and cobalt.

• PLI outlay of Rs 3500 crore, PM e-bus Sewa scheme of Rs 1300 crore, and FAME of Rs 2671 crore.

Impact:

• Reduction in manufacturing costs for lithium-ion batteries.

• Lower EV prices and faster adoption of electric vehicles.

• Growth in domestic production and auto ancillary industry.

Recommendation:

Invest. The sector is poised for growth due to favorable policies and increasing EV adoption.

Impact of Budget on Agriculture and Allied Sectors

Proposal:

• Budget outlay of Rs 1.52 lakh crore for Agri & Allied Sectors.

• Focus on job creation, skills development, and increased women workforce participation.

Impact:

• Enhanced disposable income in rural areas.

• Stimulated demand for two-wheelers and tractors in rural regions.

• Encouragement of domestic production.

Recommendation:

Invest selectively. Focus on companies directly benefiting from rural demand and agricultural growth.

Impact of Budget on Healthcare and Pharmaceuticals Sectors

Proposal:

• Budget allocation of Rs. 90,958.63 crore for health.

• Increase in Flexible Pool for RCH and National Health Programmes.

• Customs duty exemption for cancer medicines.

• PLI scheme for pharmaceuticals.

Impact:

• Reduced import dependence due to increased allocation for the PLI scheme.

• Improved health outcomes with enhanced budget for health programmes.

• Cost relief for cancer patients through customs duty exemption.

Recommendation:

Invest selectively. Focus on companies benefiting from PLI schemes and increased health programme funding.

Impact of Budget on Textiles Sector

Proposals:

• Allocation of Rs.4,417 crore for the textile ministry for 2024-25.

• Significant increase in PLI scheme allocation to Rs.45 crore.

• Increased allocation for PM Mitra scheme to Rs.300 crore.

• Employment Linked Incentives.

• Reduction in custom duties for key raw materials and accessories.

Impact:

• Continued funding and increased PLI scheme allocation will attract investments into the textile sector.

• Lower custom duties for methylene-bis, leather, and other materials will reduce production costs and enhance export competitiveness.

• Employment Linked Incentive schemes will benefit the labor-intensive textile industry, promoting job creation.

• Increased allocation for PM Mitra parks will drive investments in large-scale capacities, improving economies of scale and boosting export competitiveness.

Recommendation:

Invest selectively. Focus on companies that benefit from reduced production costs, increased export competitiveness, and those involved in large-scale production under the PM Mitra scheme. The sector shows potential for growth due to government support and incentives aimed at enhancing competitiveness and boosting exports.

Final Thoughts

Despite the initial negative sentiment, some experts believe the changes could lead to positive outcomes in the long run. The Budget's focus on maintaining fiscal discipline, with a target fiscal deficit of 4.9%, has been well received.

This focus on fiscal prudence, coupled with increased capital expenditure, strong focus on PLI, could support economic stability and growth, offsetting some of the negative impacts of the LTCG & STCG tax hikes. The simplification and increased exemption limit could stabilize investor sentiment over time. The consistency in debt mutual fund taxation and the relative advantage of equity investments, despite higher taxes, might still position them favorably against other asset classes. However, the removal of the indexation benefit for capital gains could dampen investor sentiment further. Consistency in tax policy is crucial for investor confidence, and sudden changes may lead to concerns about potential future increases.

Higher PLI Allocation in Budget 2024

The overall Production-Linked Incentive (PLI) allocation in the budget has significantly increased by 77% year-over-year (YoY) for FY25, highlighting the government's robust commitment to enhancing domestic manufacturing and export competitiveness. This substantial increase sees the Electronics and IT, Automobiles and Auto components, and Pharmaceuticals sectors dominating the PLI Scheme allocations, reflecting their strategic importance in the national economic agenda.

Notably, the allocation for the PLI Scheme for Textiles has surged by an impressive ninefold compared to the interim budget, reaching Rs 450 million, underscoring a strong push to boost the textile industry’s growth and global market presence.

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2. Detailed Analysis of Capital Gains Tax Hike on Smallcases & PMS Vs. Mutual Funds & AIFs
3. How Does The Budget Impact Your Equity Investing Strategy? Capital Gain Changes & Sector Analysis
4. Decoding Income Tax Implications on Mutual Funds in India
5. Understanding the Tax Treatment for Portfolio Management Services (PMS) in India
6. Tax on Mutual Funds - How to Avoid LTCG Tax on Mutual Funds
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Sector Rotation Strategies

• Focus on high-growth sectors like power, renewable energy, logistics and warehousing, and digital infrastructure due to strong government support and favorable policies.

• Selective investment in banking, NBFCs, insurance, agriculture, textiles and healthcare to benefit from regulatory reforms and specific growth drivers.

• Diversify investments within the recommended sectors to mitigate risks associated with individual sector fluctuations.

• Monitor sector performance and adjust investments based on the implementation and impact of budget proposals over time.

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