The last week was all about Union budget under Modi 3.0, initially about the expectations and after the July 23 of course the analysis. As the implications of these budgetary measures unfold, what is essential is to adapt and leverage the opportunities presented, ensuring sustained progress and prosperity.

 

Different Perspectives, Unified Vision

 

Each stakeholder group views the budget announcements through their distinct lenses. By addressing the diverse needs of different stakeholders – youth, MSME, Agriculture, start ups and so on. The government seeks to build a resilient and dynamic economy that benefits all sections of society through the budget announcements (panacea for all issues!!)  

 

We look and analyse the budget announcements and proposed changes with the investors POV. While these can seem daunting with terms like increased capital gains tax or the removal of indexation benefits on real estate, its crucial to understand their real impact on your financial journey.

 

Long-Term Capital Gains (LTCG) on Equity

 

The LTCG tax rate on equity investments has increased from 10% to 12.5%. This change impacts the net returns from equity investments. Investors will now pay more in taxes on their long-term equity gains. For a ₹1 crore investment in equities with an assumed 15% annual return, the LTCG at the previous rate of 10% would have been ₹1.5 lakh. With the new rate of 12.5%, the tax increases to ₹1.875 lakh, reducing the net return. For a larger portfolio of ₹10 crore, the annual tax liability is an additional ₹3.75 lakh in taxes each year.

 

In the short-term, this change may lead to some initial selling as investors adjust their portfolios to account for the higher tax rate. However, in the long term, while the increase in tax rate reduces net returns, equities remain an essential component of growth-oriented portfolios. The overall impact may be mitigated by the potential for higher returns from equity investments.

 

Removal of indexation benefit for non-financial assets

 

Indexation benefits are taken away as part of the streamlining, which makes the tax calculation easier. This was the intended objective!

 

Previously, indexation allowed for adjusting the purchase price of assets based on inflation, thereby reducing taxable gains. In the Union Budget, it is proposed to remove the indexation benefit, and LTCG on non-financial assets to be now taxed at a lower rate of 12.5% (down from 20%). This change negatively impacts short-term investments (<5 years) with moderate price growth (<10% p.a.) but is neutral or marginally beneficial for long-term investments (>10 years) with higher price growth (>10% p.a.).

 

Unintended consequence is reduced attractiveness of property investments due to the removal of the indexation benefit for real estate. Thus, the real estate market may experience reduced investment activity as investors reassess the tax implications. Alternative Investment instruments like REITs or other real estate-related investments might offer better tax efficiency and liquidity.

 

International Funds: A Renewed Opportunity

 

With a lower tax rate, the net returns from international investments improve, making them a viable option for achieving better risk-adjusted returns. In 2023, tax rule changes made international funds less attractive as they were taxed at the marginal tax slab rate, which deterred investors from diversifying globally.

 

However, the new budget has introduced a more favorable tax rate of 12.5% for international funds. Investors can now diversify their portfolios internationally. This is particularly beneficial when the Indian markets are perceived as overvalued.

 

Consider an investor who allocates ₹1 crore to an international fund. Under the previous regime, assuming a 30% marginal tax rate, the tax on returns would significantly reduce the net gains. Now, with a 12.5% tax rate, the net returns improve, enhancing the attractiveness of international investments.

 

Hybrid and Arbitrage Funds as Quasi-Debt Investments

 

Hybrid and arbitrage funds have become attractive due to favorable tax treatment, positioning them as quasi-debt investments. These funds offer a balanced investment option, providing stability and potential for moderate returns.

 

The Yellow Metal: Gold

 

The decrease in duty on gold can make gold more attractive, alongside the new LTCG tax rate of 12.5%. As an immediate response, investors might increase their gold holdings due to lower acquisition costs and favorable tax treatment.

 

Gold ETF and Sovereign Gold Bond continues to offers big benefit when compared to real gold. Gold would continue to be a hedge against inflation and currency fluctuations, making it a stable long-term investment.

 

Strategic Recommendations for Investors

• Increased diversification: Allocation to International Funds benefit from the favorable tax rate and help diversify risk. Shift some proportion of equity allocation to international funds, particularly in markets that offer growth potential and are undervalued compared to Indian markets. It is wise to combine domestic and international equities, debt instruments, and alternative assets like gold and real estate. (based on your risk profile and goals)
• Utilize Hybrid and Arbitrage funds: Given their attractive tax treatment, these funds can serve as stable, quasi-debt investments, balancing risk and return. These funds might see an increase in demand in the short term, owing to increased appeal to the conservative investors.
• Re-evaluating domestic equity exposure: Rotating investments into sectors like technology, healthcare, and green energy, which may benefit from government initiatives and global trends is beneficial.
• Mitigating the effect of LTCG: Focus on long-term holdings in high-quality equities to maximize growth potential despite the higher tax rate. Adopt strategic tax planning, including using tax-loss harvesting techniques to offset gains.
• Consider long-term investments: The removal of indexation benefits and the new LTCG tax rate favor longer holding periods, particularly for properties and other non-financial assets appreciating more than 10% annually. Adopt a buy-and-hold strategy for high-growth stocks and long-term bonds.
• Review real estate investments: For real estate, investors should evaluate the potential for higher appreciation or longer holding periods to mitigate tax impacts.

 

My dear readers,

Each investor's situation is unique, so its crucial to consider individual goals and market conditions when making investment decisions.

 

Maintain focus on the bigger picture!!

In the grand scheme of your investments, individual budget announcements are just small waves in a vast ocean. What truly matters is your consistent saving habits and the strategic investments you make. The key to long-term wealth creation lies not in reacting to every piece of financial news but in maintaining a disciplined approach to saving and investing.

 

Don’t get distracted!!

Never underestimate the power of regularly reviewing and adjusting investment strategies, aligning with changing market conditions and regulatory frameworks. Remember, unless budget announcements directly impact the future cash flows, its often best to stay the course.

 

Be aware and Beware!!

Stay informed about tax changes and plan accordingly your finances to accommodate the annual tax payments. Make necessary adjustments to the portfolio, leverage tax-efficient investment options, diversify across asset classes and geographies, and focus on sectors favored by government policies to achieve better risk-adjusted returns.

 

Best Regards
 
Dr. Tarunika Jain Agrawal Ph.D. 

Alpha Research

 

Disclaimer

The above views are our expectations of the economy, market and investments. The views may or may not play out accordingly. You are requested to do your own due diligence before making any investment.