Transaction tax set right, Dalal St parties

Suddenly, fears caused by the patchy monsoon are being discounted and traders are focussed on bullish factors like the registration of the mammoth CalPERs as a Foreign Institutional Investor (FII). At one time, the nail-biting wait for the FM’s clarification almost seemed set to end in frustration when the Opposition staged a walkout over some imaginary slight.

Finally, here is what the FM gave away. Firstly, he abandoned his worry over differential taxation within the securities markets. He now has three different STT rates for equity markets alone; in addition, he has exempted debt markets from transaction tax and has announced important concessions for mutual funds.

The FM has corrected a big Budget blunder by exempting debt trades from STT. The complete rollback shows a realisation that the market operates on extremely thin spreads and needs deepening rather than discouragement. The announcement immediately revived the bond market, which was in coma since the Budget.

The tax treatment of listed equity funds and investors’ income from mutual funds is along expected lines and units will be treated on par with securities. These two measures will ensure the urgently needed revival of both markets.

The most significant rollback pertains to equity. While retaining STT at 15 basis points for delivery transactions, it is now split between buyers and sellers.

Only 23 to 25 per cent of all trades result in delivery and FIIs and Funds who had lobbied for transaction tax account for the bulk of these transactions. While they are unlikely to complain, higher taxation on delivery transactions is a disincentive that needs to be watched carefully and corrected in future, if necessary. After all, a healthy capital market ought not to discourage investors from taking or giving delivery through higher taxation.

The slashing of STT to 1.5 basis points for day-traders and speculators and just one basis points on derivative trades is way beyond market expectations. Combined with the reduction in long and short-term capital gains announced in the Budget, Chidambaram has clearly triggered another dream run in the capital market.

But that’s not all. Until recently, profits from derivatives trades and speculative profits of day-traders were taxed as business income at a high 33.6 per cent. Also, speculative profits could only be set off against speculative losses. The FM has now allowed credit for STT against this business income and also allowed speculative losses against business income.

Interestingly, when SEBI’s expansion of the number of stocks eligible for Futures and Options trading as well as the limits on derivatives transactions comes into effect in September, it could significantly boost the Finance Minister’s revenues from STT.

One negative in the slashing of transaction taxes is that it will benefit speculators as well as those holding black money. This group of people were already celebrating the cut in capital gains tax announced earlier; they can now launder their money through the market at an even lower cost. This concession alone could bring in a rush of money into the secondary market and boost the Finance Minister’s revenues from STT.

It is now important that the FM acts on his stated objective of introducing a tax that is ‘‘neat, efficient and easy to administer’’ but also ‘‘prevents tax avoidance by bringing everybody into the tax net’’. Since stock market transactions are properly captured through ‘know your client’ data, he must ensure that the bonanza to market players leads to stricter tax compliance and brings more individuals into the tax net. But in the meanwhile, it’s celebration time at Dalal Street.