SECURITIES TRANSACTION TAX

 

Pranati Kumari

 

INTRODUCTION

 

The Union Budget 2004-2005 proposed a paradigm shift in the taxation of capital gains on financial securities by introducing the Securities Transaction Tax (hereinafter refer to it as STT). Transactions in stock and index options and futures would also be subject to transaction tax .Whereas transactions carried out on the Negotiated Dealing System (a screen-based system for trading in government securities and bonds) operated by the central bank, Reserve Bank of India, have been kept out of the purview of this tax. Only the buyers of securities would pay the proposed tax. After collecting this tax from the buyer, the broker would pay it to the stock Exchange, which would then pay it to the exchequer.

 For years together, the profit on sale of securities like shares, debentures, bonds, units of Mutual Funds, et al, was calculated in different ways and was also subject to income-tax at different rates depending upon the period of holding. However, the Finance (No 2) Bill, 2004 introduced by the honourable Finance Minister, Mr P Chidambaram, while presenting his much awaited Union Budget 2004-2005, had ushered a paradigm shift in the taxation of profits on financial securities which came into effect from the assessment year 2005-2006 (financial year from April 1, 2004 to March 31, 2005).

 

The Finance Ministry have supported the introduction of the STT in order to simplify the tax regime on financial market transactions. The authorities believe that the STT is a clean and efficient way of collecting taxes from financial markets. That is why, the introduction of STT has been linked with the dismantling of existing tax structure on capital gains. While introducing the STT, the Finance Minister proposed to abolish the tax on longterm capital gains altogether and reduced the short-term capital gains tax from 33 per cent to10 per cent.

 

There is no denying that STT could act as an efficient instrument to collect the taxes, as many market players fudge transactions to evade capital gains taxes but it would be erroneous to consider STT (indirect tax) as a substitute to capital gains tax (direct tax). If there are problems in collecting capital gains taxes, these should be sorted out rather than reducing and abolishing it altogether. Further, to justify the introduction of STT only in terms of smooth collection of taxes would be a serious mistake. 

 

DEMYSTIFYING SECURITIES TRANSACTION TAX

The Budget 2004-05 proposed to introduce a “securities transaction tax” (STT). In the words of Mr P Chidambaram, STT is a neat, efficient and easy-to-administer tax and it has the great advantage of virtually eliminating tax avoidance.

The STT is applicable at different rates on the value of the “taxable securities transaction,” which again is defined to mean a transaction of purchase and sale of securities entered into in a recognised stock exchange in India on or after the date on which Chapter VII of the Finance (No 2) Bill, 2004 comes into force (i.e. the specified date) and is payable by the buyer and the seller of the securities.

Definition of securities

The term "Securities" is not defined in the Income tax Act,1961 but at several places, the meaning of this term is stated to be the same as defined in section 2 (h) of the Securities Contracts (Regulation) Act,1956. According to this section, "Securities" include:

i)                    shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

ii)                    derivative;

iii)                  units or any other instrument issued by any collective investment scheme to the investors in such schemes;

iv)                  security receipt as defined in section 2(zg) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

v)                   Government securities;

vi)                  such other instruments as declared by the Central Government; and

vii)                rights or interest in securities.

After the presentation of the Budget on July 8, 2004, Mr P Chidambaram had also announced that securities would be defined to include equity-oriented mutual funds (not debt-oriented mutual funds) but exclude debt instruments. Further, under Section 2(f) of the SCRA, a “recognised stock exchange” means a stock exchange, which is for the time being recognised by the Central Government under Section 4 thereof.

Moreover, the value of “taxable securities transaction” is to be determined as under:

Option in securities: The aggregate value of the strike price and option premium

Futures: The price at which such futures are traded

Other securities: The purchase price for a purchaser and the selling price for a seller .

        Therefore, when one buys securities on or after the specified date, STT is to be paid irrespective of the future holding period giving rise to long-term or short-term capital gains or business profits; and the investor or trader earning a profit or suffering a loss. But, in the case of day-traders, arbitrageurs and derivative traders, who are paying income-tax on business profits, for non-delivery-based and delivery-based transactions, credit for STT will be available against the income-tax payable on business income there on.

CHANGE IN THE TAXATION OF LONG-TERM AND SHORT-TERM CAPITAL GAINS

In respect of securities, as has been already defined in chapter 1, sold on or after the specified date on a recognised stock exchange in India, long-term capital gains will be exempt under the proposed Section 10 (38) of the Income-tax Act, 1961 (the Act). Similarly, under the proposed section 111A of the Act, short-term capital gains on securities, sold on or after the specified date on a recognised stock exchange in India, will be taxed at a rate of 10 per cent before levy of surcharge (for an individual and a Hindu undivided family having taxable income not exceeding and exceeding Rs 850,000 at nil and 10 per cent respectively and for others at the rate of 2.50 per cent) and education cess of 2 per cent on the aggregate of income-tax and surcharge taken together for all other taxpayers. However, in respect of securities sold before the specified date or after the specified date, which does not meet the conditions stipulated above, would be taxable before the levy of surcharge and education cess at the following rates: Long-term capital gains: 10 per cent without indexation benefit or 20 per cent with indexation benefit, whichever is lower.[1]

Short-term capital gains: At The Regular Rate Of Income Tax

There is no change in the taxation of business income, which is taxed at the regular rate of income-tax except that credit would be available for STT from the income-tax payable i.e. income-tax on business profits would be reduced by the amount of STT.

RATIONALE  OF STT IN INDIAN FINANCIAL MARKET

There are several justifications for the adoption of STT in the Indian financial markets. Some of them are as follows:

Firstly, the underlying logic of securities transaction tax is to slow down the flow of speculative money, as it would be taxed each time a transaction takes place. The STT is expected to curb purely short-term speculation by day traders, “noise traders,” arbitrageurs and big operators without significantly affecting the long-term investors. The tax on equities held for a long period would be marginal while the tax on short-term trading would be higher.[2] The STT would be a significant deterrent to speculators and day traders trying to make a quick profit on a huge sum by just trading, without taking any deliveries of stocks. The proposed tax would keep such players away, as they would have to factor in the tax cost. The STT is expected to reduce the speculation in Indian financial markets, which are amongst the most speculative markets in the world. Compared with several leading international financial markets, the sheer volume of speculative trading in Indian markets is extremely high.

 Despite a sharp increase in the daily turnover in the Indian financial markets, actual deliveries are less than 20 per cent of trading. Due to excessive speculation, much of trading in the Indian markets is concentrated in a handful of stocks. The top 10 stocks account for over 80 per cent of the turnover of the Indian financial markets. The top 100 stocks account for almost 99 per cent of the turnover. While there are several thousand stocks listed in the markets that are not traded at all. The speculative nature of Indian financial markets can also be gauged from the fact that the volume of secondary market trading has increased several times while new capital raised through primary market has significantly declined over the years. Over the years, we have witnessed that excessive speculative trading by big players more often than not degenerates into market manipulation. There is an entire history of frauds in the financial markets starting from the securities scam of 1992.[3] The financial frauds recurring at regular intervals reveal that our financial markets are prone to abuse, manipulation and excessive speculation.

 India has also the distinction of having extreme price volatility at the individual stock level. Short-term trading is one of the major factors responsible for increased market volatility. By raising the cost of speculative trading, STT would contribute towards restraining short-term trading, thereby making Indian financial markets less volatile and more efficient.

 Secondly, the revenue potential of a 0.15 per cent of STT provides another justification. On an average, the daily trading in the Indian stock markets is about Rs 100000 million. By imposing a 0.15 per cent STT on this volume, the Indian tax authorities can collect Rs 150 million every day. As Indian financial markets operate on an average 250 days a year, STT could generate revenue of Rs 37500 million every year. This is a substantial amount in the present times when country is finding it difficult to raise revenues through taxation. India’s tax-GDP ratio is among the lowest in the world and has fallen particularly in the 1990s – the decade of economic liberalization and globalization.

 

Further, the need of the hour is to tax the financial economy that has remained under taxed despite tremendous growth in the recent years. To a large extent, this has happened due to several loopholes in the present tax system, which have been consistently exploited by the big operators in the financial markets. For instance, the foreign institutional investors (FIIs) avoid paying taxes in India by routing their investments through Mauritius, which has signed double tax avoidance treaty with India. Under this treaty, corporate bodies registered in

Mauritius would be taxed under the Mauritian law rather than Indian law. Since Mauritius does not tax capital gains and dividend, it is no surprise that bulk of portfolio investment as well as foreign direct investment into India is routed through Mauritius. But once the STT is implemented in India, evasion of taxes by the FIIs and other international fund managers through such tax treaties would be effectively curbed.[4]

 

Thirdly, an additional advantage of STT is that it could discourage “hot money” flows, which are known for their volatile and destabilizing behavior. As recent international experience shows that developing countries are more vulnerable to “hot money” flows, STT could ensure some degree of insulation to the Indian financial markets from the deleterious effects of such volatile financial flows.

      

       Fourthly, by cutting back financial resources in unproductive speculation, STT could encourage long-term financial flows. The speculative activity in the financial markets diverts large amounts of resources away from productive purposes. As a result, fewer financial resources are available to fund long-term economic development. In the long run, STT has the potential to benefit the real economy.[5]

        

       Fifthly, the securities tax is much easier to implement. It is a clean and efficient instrument of collecting taxes from financial markets as collections will be centralized through the stock exchanges. Further, STT does not require any international consensus or agreement to levy it. India, like any other country, is free to levy STT.

CONCLUSION

While favoring the implementation of STT, the researcher is not arguing that all problems related to speculation and volatility in the Indian financial markets would be resolved by it. In the present times, no single instrument by itself can solve all problems plaguing the Indian financial markets. However, if used in conjunction with other policy mechanisms (e.g., banning short selling and insider trading), STT does offer a potent mechanism to deal with the multiple problems. Therefore, any attempt to dilute the provisions of the proposed tax should be strongly opposed by all those who are concerned about stability in the Indian financial markets.

 

Shares transactions are now being effected by a very wide spectrum of people in the country. The various provisions of tax laws must therefore be understood by them and by their tax advisors properly so that the best use of provisions granting various incentives and relief can be made.

 



[1]http://economictimes.indiatimes.com/News/Economy/Policy/IDRs_to_attract_securities transaction_tax/articleshow/3374596.cms accessed on 16-01-09 at 6.10pm.

[2] The Case for a Securities Transaction Tax in India, ASED-PIRC Briefing Paper, 2001 available online at

www.ased.org as accessed on 17-08-09 at 5.30 pm.

 

[3] See, for instance, B. G. Shirsat, “Indian Bourses Second-most Speculative after Nasdaq,” Business Standard, April 5, 2001; and Rishi Chopra, “Excessive Speculation Plagues Capital Markets,” The Economic Times, May 8, 2001.

 

[4] Supra 3.

[5] http://www.macroscan.com/cur/jul04/pdf/equitable_equity.pdf accessed on 17 -01-09 at 12.30 pm.