Households, companies and governments all save and borrow. In India, households, in aggregate, save more than they borrow. We park those savings in physical assets such as real estate and gold, and in financial assets such as cash, bank deposits, mutual funds, equities, insurance and pension plans. The household savings mix has been tilting the wrong way in recent years, with net household financial savings hovering near just 5% of GDP.
Within financial savings instruments, more households, especially of the younger generation, now save through the equity market. Investors registered with the National Stock Exchange crossed 130 million in March, and around 35.5 million of them trade in a given year, up from 4.6 million a decade ago, with their participation reaching almost 99.9% of the country’s pin codes.
Many have been drawn to mutual funds (MFs) through systematic investment plans, or SIPs, a route seen as safer than picking stocks for one’s own portfolio.
Saving through the market, however, carries a charge that saving through property does not—one that most young investors realize the first time they want to shift their money into a different stock or mutual fund.
While the long-term capital gains (LTCG) tax rate is now the same at 12.5% whether the asset is, say, a flat or a mutual fund, our law does away with the requirement to pay the tax on real-estate capital gains if the seller purchases another house, thereby letting the family roll wealth from one house to another indefinitely without inviting tax liability. But no such equivalence exists for a saver who wants to reallocate savings among financial assets.
This anomaly needs to be corrected if we are serious about channelling India’s savings into productive assets and raising financial savings.
Consider an individual who sells a house at a profit. If she buys another within two years of the sale, or within a year before it, or builds one within three, then she pays no tax on capital gains up to ₹10 crore—repeatable across any number of such home switches in a lifetime, so long as the new house is held for at least three years.
If she would rather not, she can shelter up to ₹50 lakh in certain specified bonds for five years to save on tax. Only if she wants neither does she have to pay LTCG at 12.5%. For properties bought before 23 July 2024, she can opt for an older 20% rate option that comes with indexation if that turns out more tax efficient. In short, as long as the wealth stays in real estate, capital gains tax can be avoided.
Now consider someone who has saved in stocks or MFs or even bank fixed deposits (FDs). If she switches, say, from one MF scheme to another after a year, she pays 12.5% LTCG on gains above ₹1.25 lakh (with no indexation benefit), even if she re-invests every rupee immediately. If you switch to another scheme or stock within a year, you pay 20% tax on short-term gains. Capital gains on debt funds bought are now taxed at one’s income-tax slab rate, no matter how long one held them.
For anyone with a meaningful corpus of savings, the only way to save tax is to lock savings into a particular stock or MF even if that means having to stay in a scheme whose returns have weakened.
This falls hardest on the buy-and-hold saver who a maturing market most needs and on those whose investments in equity predates the introduction of LTCG on equity investments in 2018. For someone who saves in FDs, even that option doesn’t exist as FDs have a fixed maturity period.
None of this is to say that there are no tax concessions on financial savings, or that there are no other taxes on real estate. A buyer pays 5-7% as stamp duty on a flat purchase, while provident funds, pension schemes and equity-linked saving schemes are eligible for tax concessions. But those concessions apply mostly to illiquid, government-directed instruments where in some cases the government uses the corpus to fill its borrowing requirements.
The Union government told Parliament in July that LTCG on equity yielded ₹1.29 trillion in 2024-25. But taxing a gain realized and spent differs entirely from taxing a gain while shifting between financial assets. Further, the home rollover route encourages the equity investor to convert it into physical savings: such gains can be sheltered from tax by buying a house, if she does not already own more than one home.
The fix is not complicated. India should extend to financial assets the treatment its tax code reserves for homes: no tax when proceeds are re-invested in the same savings instrument, within a specified time window, with the full gain taxed on final exit.
This will be easier to administer than for houses, as demat records track every purchase price, unlike land registries. Taxing a reshuffle that never leaves the market only keeps savers locked in sub-optimal schemes. The remedy will encourage savers to put more money in financial markets, raising the funds available for productive investment in the corporate sector and lowering its cost.
That said, everything has a trade-off. Tax revenue forgone without an offset will widen the fiscal deficit, leading to more government borrowings, a potential rise in interest rates and a crowding out of private borrowers. So, as an offset, the government could consider imposing income tax on farm income beyond the minimum threshold applicable to other citizens, apart from trimming subsidies.
At the very least, let us start discussing the impact of tax anomalies on savers.
The author is Union Bank Chair professor of economics, Great Lakes Institute of Management