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Should you believe Modi's warning or Jaitley's reassurance?

Will the FM's soothing words overcome the PM's irritation? Maybe, but you should act now to protect your long-term capital gains from a hefty tax

Should you believe Modi's warning or Jaitley's reassurance?

"To some extent, the low contribution of taxes may also be because of the structure of our tax laws. Low or zero tax rate is given to certain types of financial income." Back in December, Prime Minister Narendra Modi gave a scare to equity investors with this statement. In an address delivered at a function of the National Institute of Securities Markets (NISM), he basically read out the riot act to the financial markets. The thrust was that they'll have to pay more tax out of the money they make, stop stealing on taxes if they're doing that, and transform themselves into conduits for generating capital for growth rather than channels of speculation and investments.

However, it was the zero tax bit that struck fear in the heart of the markets. The reason was clear--today, if you hold an equity or equity-based mutual fund investment for more than a year, then the gains are zero-tax. In all of securities investing, this is the only incidence of zero tax on capital gains. Through his statement, Modi made it clear that he thought that this was unfair. For the markets, it was reasonable to assume that this was a clear signal that zero tax on Long Term Capital Gains (LTCG) was on the way out in the 2017 budget. Obviously, the markets reacted in panic because panic is the markets' favourite reaction to anything.

A couple of days later, Finance Minister Arun Jaitley countered this impression by explaining at length that the PM's remarks had been misconstrued and that he had cast no aspersions on the zero tax regime. He said, in his lawyerly way, "I wish to absolutely clarify that there is no occasion or opportunity for anybody to reach such a conclusion because this is not what the Prime Minister said, nor is the intention of the government as has been reported."

Should you believe that? I think there are three possibilities. One, LTCG is really going to be taxed. Mr Jaitley did say that the government had no intention of doing so, but then that's what he would be constrained to say even if it did. I'm reminded of the incident when Lalu Prasad Yadav's party had just lost power in Bihar. During the campaign, he had confidently proclaimed a huge majority. When he was asked about that after the results came out, he calmly responded that he could hardly have admitted that he was going to lose. Mr Jaitley too can just impose an LTCG tax and say that he could surely not have admitted that he was going to do so.

The second possibility is that the tax will not be imposed as such but the minimum investment period required to qualify will be increased from one year to three years. This is exactly what was done for a different class of investments (debt funds) last year. It effectively increases tax revenues while letting zero tax stay for genuinely long-term investing.

The third possibility, of course, is that the Prime Minister was just letting off steam and Mr Jaitley and his team will brush away Modi's concerns and everything will continue as it is.

So what should you do? The question is important because in case one or two, those who are holding unrealised long term capital gains can easily (and legally) protect these from tax. They can sell the holdings and immediately reinvest the sum redeemed back in the same investments. This will protect their past gains from the future changes in the tax structure.

But what if it turns out to be case 3 and there is no change? Groucho Marx once said that hard work never killed anyone but why take a chance? In a somewhat similar fashion, you may trust Mr Jaitley and believe that the zero tax will stay, but why take a chance? If you do the round tripping of your long-term equity-based investments as I've suggested, you'll save yourself from a chance of paying a hefty tax and it will cost you a comparatively miniscule transaction cost and tax. So if you have any such gains, I'd suggest that you act quickly. These are the kind of tax changes that are made effective immediately as they are announced, rather than waiting for February 1. Effectively, you have just one week to shake off your inertia and protect your long-term gains. Don't wait any longer.