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Budget & Financial Markets: How the Budgeted refrained from negatives…

Economy | Published on Feb 10th 2017 | Comment(s) 0
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From a policymaker’s perspective, there were a fair amount of negative expectations built around the Union Budget. More so, from a capital market perspective! Interestingly, the budget refrained from most of these negative expectations which was well received by the market. Normally, budgets are not just evaluated in isolation but with reference to the expectations built around them. This budget scored very highly on that front. In fact, the government virtually refrained from most of the major negative expectations that were built up ahead of the Union Budget. Here are 6 instances where the government positively surprised the markets…

 

No tax on long term capital gains…

 

In the aftermath of the Prime Minister’s speech in Mumbai calling upon capital markets to contribute more to nation building, there were strong expectations that there could be additional impact on equity investors. Equity does get special treatment in terms of definition of capital gains as well as the rate of tax payable. Both these were set to change. It was expected that the definition of long term gains may be modified to 3 years and LTCG may be made taxable in the hands of the investors. Interestingly, the budget refrained from both these measures. The expectation had become prominent in this year due to the changes in the Double Taxation Avoidance Agreement (DTAA) with key geographies like Singapore and Mauritius. However, the government refrained from making any changes to long term capital gains on equities. That will be a big relief for equity investors.

 

Concessional tax on short term capital gains to continue…

 

That was another fear that had built up on equity markets. Currently short term capital gains on equities (holding period of less than 1 year) attracts a concessional tax rate of just 15%. The expectation was that to give parity with other sources of income like salary, interest on bonds and other receipts, the rates of tax on short term capital gains may be increased. All the other sources of income are currently taxed at the peak rate of tax while STCG gets a concessional rate of 15%. However, the budget refrained from raising the tax on STCG. This is a big positive for equity markets as a lot of retail interest in equity markets in the last few years has been due to the concessional treatment for STCG on equities. This will ensure that the retail participation in equities (which is already much below global averages) stays robust.

 

No tinkering with taxes on dividends…

 

Dividends are tax-free in the hands of the equity investors. That is justified because dividends are a post-tax appropriation for a company. Since the tax shield is not available to the company paying dividends, any effort to tax dividends in the hands of the investor amounts to double taxation. However, there have been attempts to tax dividends in the recent past. For example, the dividend distribution tax (DDT) was introduced a few years which indirectly reduces the dividend payout. In the previous Union Budget 2016-17, the FM had imposed an additional 10% tax in case your annual dividends exceed Rs.10 lakhs. In this budget it was expected that either the rate of tax on HNIs could be enhanced or the limit lowered. There were also expectations of taxing dividends per se in the hands of the investor. Fortunately, the government refrained from making any changes here.

 

No progressive tax pressure on higher income groups…

 

One of the big advantages of this Budget was that it refrained from being a typical Robin Hood budget. Since the government has been traditionally committed to progressive taxation (making higher income groups contribute more), it was expected that there may be a higher burden on higher income groups and a reduced burden on low income groups. To the credit of the government, the rates of income tax at the entry level (Rs.2.50 lakh to Rs.5.00 lakh) were actually cut from 10% to 5%. This will be a bit boost to consumption. On the other hand, those in the higher income group (Rs.50 lakh to Rs.100 lakh) will just pay an additional surcharge on income tax of 10%. This is a marginal increase in tax and will be viewed positively by investors at large. More so, because it is this higher income group that has a higher propensity to invest in equities.

 

Thankfully, no increase in service tax rates…

 

This was, probably, the biggest boost for equity investors. The rate of Service Tax which is currently at 15% (14% ST + 0.5% Krishi Kalyan Cess + 0.5% Swacch Bharat Cess) was expected to be increased to 18%. This would be in tune with the GST rate which stipulates a range of 12%-18%. It was expected that while tax on essential services may be pegged at 12%, most of the other services may attract tax at 18%. This would have been substantially inflationary and would have made a dent on profits of companies where the impact would have resulted in fall in demand. By refraining from increasing the rates of service tax, the government has once again managed to please equity market investors.

 

Union budget maintains fiscal discipline; says no to pump priming…

 

At a macro level, the expectation was that the government would resort to pump prime the economy in the aftermath of the demonetization drive. This would have meant that the government would slip on its fiscal deficit target to spur growth. However, contrary to popular expectations, the government decided to stick to fiscal discipline by pegging the fiscal deficit at 3.2% for fiscal year 2017-18 and at just 3% after that. This fiscal discipline will be a major boost from the point of view of global rating agencies and foreign portfolio investors.

 

To sum up, this budget has been special not just for its announcements but for what it has refrained from announcing. For resisting these popular temptations, the budget surely deserves to be lauded.

 




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