Since the announcement of LTCG tax on Equity, the markets have not quite settled, and so the investors. You must have been pestered with questions by now, “Do I have to pay a tax on my Investment now?” “You said I'll get tax free Returns?” “Should I sell my investment, so that I don't have to pay any tax?”, and the like. The minds are blocked by perceptions because every newspaper and TV channel has a different story to narrate, which is also the primary factor behind the hype.

How do you answer the questions, and explain the impact of the announcement on the investor's investment is the major challenge at this point of time. It is crucial to give a satisfactory response and demystify the investor' apprehensions,

What's the New Law

Long Term Capital Gains (Investment period > 1 year) of above Rs 1 Lakh from Equity stocks and Equity Mutual Funds, will now be taxed at 10%, which was fully exempt earlier. However, the gains made until 31^st Jan 2018 will be grandfathered, meaning the capital gains made on the investment until 31^st Jan 2018 will be exempt.

Tax Calculation: Amongst the most asked questions by clients at this point, is the tax calculation part. How will the grandfathering work? How much tax will be due on existing equity investments? How about new investments?, etc.

We have the following illustration, which shows the LTCG tax impact on an investment made in an Equity Mutual Fund on different dates, this will help you in solving a lot of queries:

Assumptions:

Investment Value on 31^st Jan 2018 (Grandfathering Date): Rs 5 Lakhs

Redemption Date: 1^st May 2019; Value on Redemption Date: Rs 620,000

So, the above table shows that investors do not have to worry about the gains they have made historically, since all gains made prior to 31^st Jan 2018 are tax free. As we see in the table above, in the first case, on a total gain of Rs 210,000 made over 2 years, the tax liability comes to just Rs 2,000. Also, long term capital gains made after the grandfathering date, upto Rs. 1 lakh, will be exempt.

Focus should be on the Goal: Further, it's not just about tax, the investors must realize that they invested in Equity Mutual Funds with a goal in mind. If they are being skeptical about their investment, ask them if they have fulfilled the goal, if not, how do they plan to provide for the goal? Urge your investors to not go astray. If their goals are still far way, they don't need to worry about tax, rather they should stick to their investments.

Another stance of volatility: You might have nervous investors, especially the ones who may have lately started an SIP, they might not be able to digest the falling NAV's for they aren't yet accustomed to the ups and downs of the market. These investors must be reminded of the inherent volatile nature of Equity markets, you have more than a three decade history packed with instances where markets have dwindled to some news or the other, like this time it's LTCG tax, but it was only a temporary phase, because in all the cases, the markets regained, without fail.

Handholding: The investors need your support at this point of time, if their doubts remain unresolved, they might end up exiting equity and succumb to products which may not conform to their risk profile and investment needs. You lose a client and they might lose a good investment.

To conclude, the cause of the confusion and panic can be largely attributed to lack of clarity. The investors are not likely to go anywhere just for a 10% tax on returns, because there is no other asset class or investment product which can still match Equity, in terms of returns. However, it's important that the investors should not be left to themselves wondering about the connotations of the new tax, they should be explained the impact of the tax with concrete examples, plus they should be reminded of the rudiments, the reason behind investing is not tax saving, but creating wealth and fulfilling goals.

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One of the most vital roles played by financial advisors is managing behavioural biases of their clients, who are stuck between timing the market, following the herd, chasing returns, among others; thus creating substantial value over time. There is a plethora of literature available on behavioural bias affecting investment decisions and how to overcome the bias, but most of this information caters to one side of the story only, the Investor side. Apparently financial advisors too are victims of the paradigm, but seldom would they realize that the advice they deliver may also be clouted by their emotions or behavioural bias. The investors are better off as you are there to help them overcome their bias, but in case of advisors, the challenge is, it's only you who can help yourself. Hence, for an advisor keeping a check on your own emotions along with the clients', becomes paramount.

And a super way of overcoming such biases is to be aware of them, as the first step to solving a problem is understanding it. So, here are some emotional prejudices which may be dominating your judgment and decisions, needed to be taken care of.

Heuristics: Heuristics typically means applying mental shortcuts, that is processing only a part of the information received or processing the information incorrectly, when there is inflow of a large amount of data. Financial advisors too at times apply heuristics by processing partial or incorrect information while advising clients. Say for instance, the client under consideration is a young unmarried person, we may assume he has a high risk appetite, which may not be the case, and base our advice on the basis of our subjectivity. An advisor must never have a presumed background, each investor is different, we should always draw the sketch on a plain white canvas.

Industry Trend Bias: Another phenomenon that impacts advisors' judgment and the advice they deliver is market trends. Like other individuals, advisors too tend to believe that the market trend will continue. For Example, when markets are on the bull run, advisors believe that the upsurge will continue for a while and base their advice on this belief. The irony is they understand the fact that the direction of the markets cannot be predicted, yet they get influenced by trends. Even if it is highly likely that the bull trend will continue, yet it's wrong to base your decision on the likeliness. You never know the markets might start correcting from the next day. Take the example of the recent bit-coin rally and the subsequent downturn, when the coin was taking giant leaps and surged to US$15,000 levels, people started believing the trend will continue for at least some time, until the coin's pace was thwarted and it changed course.

Familiarity Bias: Another cognitive bias often seen in advisors is tendency to prefer familiar, tried and tested products. Real Estate or Gold can be a good example of the Familiarity Bias. Because people were familiar with these asset classes, they did not look beyond them, and both sectors witnessed sluggish growth over the last decade.

Familiarity Bias in advisors has two drawbacks:

1. Lack of proper diversification in the client's Portfolio. Your preference for let's say equity, will result in over concentration of Equity in the client's Portfolio.

2. Unable to meet specific needs. The investor who is looking to invest in a product, which isn't your forte, may not get the solution from your end.

Anchoring: Anchoring is one of the most common behavioral bias, witnessed in both, advisors as well as investors. Anchoring means when we consider our past experience as a foundation to base our future decisions on. And it is very difficult to modify our perceptions of products based on our first experience. We may have had a pleasant experience with a particular sector in the past, and there are chances we may have anchored the episode to the extent that all our clients have that particular sector in their Portfolios, irrespective of it's relevance in the Portfolio.

So these were some of the most common behavioural biases, among others, witnessed in financial advisors. The crux is it's not just our investors who are not letting go their emotions and biases while investment decision making, quite often we advisors might also be influencing our clients' portfolios with our emotional biases. It is extremely important for advisors to understand these biases and get over them, and deliver fair advice, which is unaffected by judgments or prejudices. It is a continuous task to guard yourself and them against bias.

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There are certain amendments proposed in the union budget FY 18-19 with respect to investments in equity and equity oriented mutual funds. Find below the summarized note on each of the important point.

A) Updated Tax Structure:

The following is the updated tax structure applicable from 1^st April, 2018

(For Resident Individuals / HUF)

Additional: Health & Education Cess of 4% + Surcharge based on total income applicable to Capital Gains.

* Cost as per fair market value / grandfathered upto 31^st January, 2018.

B] Long Term Capital Gains (LTCGs)

The recent budget provisions have created some confusion in the minds of investors regarding taxability of mutual funds units, especially for equity oriented funds. Here is the some clarification for same.

Summary:

Any Long Term Capital Gains (LTCG) over Rs 100,000 per year on Equity Mutual funds will now be taxed at 10%. All gains until January 31, 2018 have been "grandfathered". So one can now assume that the new cost of holding your Equity Mutual Funds is the closing price on January 31, 2018. The start date of your holding remains the original purchase date for calculation of holding period.

Applicability:

Since the budget provisions are effective from 1^st April, 2018, any transaction taking place till 31^st March 2018 will continue to enjoy the existing taxation provisions. Thus, there would not be any LTCG (applicable on any sale happening on or till 31^st March.

Grandfathering:

The grandfathering is a simple concept wherein the Finance Minister has given exemption of all notional Capital Gains earned till 31^st January 2018. This means that for calculation of LTCGs, all gains made till this date will be exempted and not counted. As explained earlier, the tax computation will only be applicable by this method if the sale date is on or after 1^st April, 2018 when the budgetary provisions come into effect.

Calculation for STCG:

The scenario for STCG calculation effectively remains the same as is currently in effect. The tax rate of 15% will continue be applicable if the sale happens within 365 days of purchase of the equities / units.

Calculation for LTCG:

For LTCG, the following is the calculation method:

Purchase price is to be considered higher of (a) and (b). (the idea is that only gains made after 31^st Jan is taxable) .

a) Actual purchase price

b) Lower of ...

i) Fair market value (it is the highest price /market value as on 31^st January, 2018)

ii) Full value of consideration (it is the actual sale price).

Examples:

1. Actual purchase price = 100. Market value on 31.01.18= 110. Sale price = 90. Then Fair purchase price = 100.

2. Actual purchase price = 100. Market value on 31.01.18 = 110. Sale price = 120. Then Fair purchase price = 110.

Exemption of Rs.1 Lakh:

Next, for calculation of final LTCG amount applicable to taxation, the exemption of Rs.1 lakh is applied. Thus if LTCG as per above is say Rs.1,20,000 then 10% on only Rs.20,000 = Rs.2,000 only would be appliable.

This is applicable irrespective of any purchase date and any amount of capital gains and is effective any sale made on or from 1^st April 2018. For any sale date before that, LTCG is not applicable so the exemption amount is immaterial.

Scenarios:

This is the clarification available till now. There are still more clarifications awaited which shall be received in days to come.

C] Dividend Taxation:

Dividends on Equity oriented Mutual funds now taxed at 10%. This provision had to come into effect since LTCG tax @10% is also imposed. Not doing so would have left a window to avoid LTCG tax by switching to dividend options.

This change will also be effective from 01 April 2018.

To assist you in understanding and calculating capital gains tax liabilities we have prepared a Capital Gain Calculator also, Click here to download it.

Download the Frequently Asked Questions (FAQs) regarding taxation of long-term capital gains proposed in Finance Bill, 2018-reg. released by the Income Tax Dept on 4th Feb 2018. Click Here to download

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