Securities Transaction Tax – Effect on The Indian Capital Markets
Pramod Kumar

Securities Transaction Tax otherwise called ‘Tobin Tax’ is any tax, fee or duty imposed by the Government on transactions pertaining to buying, transfer or selling of securities. It has both the positive and negative effects on the price discovery, volatility, and market liquidity in securities market. International experience of such taxes can be seen across the globe on buyers (United Kingdom, 0.5%), sellers (Japan), both (France, 50% buying, 50% selling), Sellers (Indonesia, 0.1 percent), selling (South Korea, 0.15 percent of listed securities) and selling (Taiwan, 0.30 percent on equity and 0.10 percent on debt sales).

Many countries had the provision of securities transaction tax although they were subsequently altered either due to the market reaction or on achieving of the objective for which it was introduced.

Now let us study at some of the international experiences on securities tax before we look at the same in Indian scenario. Marion G. Wrobel (1996) asserted that most of the research was done on United Kingdom and Sweden even though there were several countries that imposed such taxes. But that imposition was limited to the attainment of certain objective.

Sweden saw the securities transaction tax imposed in the year 1984, 50 basis points for buying and selling of equity security. Later in July 1986 the rates were doubled and in 1989 a tax on fixed income securities was also introduced pegged at 0.2 basis points for a security with maturity of 90 days or less.

On April 15, 1990, the tax on fixed income securities was abolished. This was followed with tax rates on equities reduced to half by the end of January 1991 and later abolished. Many factors were attributed to such alteration, first and the most important was the change in political scenario.

United Kingdom introduced stamp duty applicable on registration of securities. Whenever any transaction involves change in possession of the asset attracted stamp duty, however non-residents, trades in foreign securities were exempted. The concept of stamp duty was introduced in 1974 pegged at 2% later reduced to 1% in 1984 and in 1986 it was 0.5% that is also applicable currently.

Japan L.H Summers and V.P Summers (1989) introduced a Financial Transaction Tax in the late 1980s fetching revenues of around US $12 billion per year. In that period the tax was both on the debt instrument (3 basis point – 0.03%) and equity instrument (30 basis points – 0.30%). Recently Japan also initiated the process of introducing transaction tax on derivative segment.

Pollin et al (2002) has given an International comparison of securities taxes imposed in countries around the world. The following table gives the compilation of taxes in 19 countries, although modification has been done to the taxes recently in the Union Budget 2004-2005.

INTERNATIONAL COMPARISION OF SECURITIES TRANSACTION TAX

 Source: Pollin et al (2002: Table 1)

INTRODUCTION OF SECURITIES TRANSACTION TAX IN INDIA

We have discussed the pros and cons of transaction taxes across the globe. This paper aims at discussing the implications of introducing securities transaction taxes in Indian markets.  With the recent Union Budget 2004-2005 announcing Securities Transaction Tax, India is now among those countries where such taxes are applicable. Initially a common tax of 0.15% was introduced, which is, depicted in Table I.

Table I

ORIGINALLY INTRODUCED TRANSACTION TAX

Impact on Equity Markets

There was a sharp fall in Bombay Stock Exchange Sensitivity Index (SENSEX) of more than 100 points although recovered lately. There were fears that such a tax would dry up the volumes on the exchanges as around 60-70 percent of transactions in Bombay Stock Exchange (BSE) comprises of day traders who buy and sell (speculate) for meager margins associated with huge volumes. The futures market transactions will also be effected by this levy.

Impact on Bond Markets

During the announcement of securities tax the bond market had seen a sharp drop in trading volume to approximately Rs 400 crore (Rs 4 billion) as against daily average trading volume of Rs 3500 crore (Rs 35 billion).

MODIFICATION OF STT

Impounding pressure on the government from FIIs / Brokers / Investors forced a rollback leading to alteration of such figure into four categories. Table II explains the modified form of the Securities Transaction Tax.

Table II

APPLICABLE MODIFIED TRANSACTION TAX

* Tax on Equities will be only on delivery transactions

It can be concluded from Table II that the new proposal has put all dealing in bonds and government securities out of the STT’s purview that will provide boost for the debt market segment.

This implies that debt fund investors would be taxed with long-term capital gains at the rates 10 percent without indexation benefits and 20 percent with indexation benefits. Short-term capital gains will be taxable at the marginal rate of income tax.

The investors in equity-oriented mutual funds would benefit from these, as they will enjoy the same benefit as those enjoyed by delivery based equity transactions i.e., short-term capital gains will be charged at a flat rate of 10 percent and exemption from long-term capital gains.

ADVANTAGES OF STT (INDIAN PERSPECTIVE)

What led the government to introduce such a tax on securities; one view could be an easy and effective way to collect the tax from financial markets as most of the investors succeed in evading tax on capital gains. Which is evident as the government has abolished the long-term capital gains and reduced short-term capital gains from 33 percent to 10 percent (5). This is a huge benefit for those Financial Institution Investors who are not taking the Mauritius route to avoid short-term capital gains tax.

DISADVANTAGES

There could be possible disadvantages of security transaction tax keeping the facts and figures of international experiences. Although it need not be the same but may contribute some of its aspects.

a) The modification of Security Transaction Tax would lead to a revenue loss of approximately Rs 6,000 crore (Rs 60 billion) for the fiscal year 2004-2005 to the government. This is attributed to the factor of not modifying the Long Term Capital Gains and Short Term Capital Gains with respect to rollback of originally proposed Securities Transaction Tax.
b) The Economic Times (2004) Estimated revenue as a result of rollback of STT and subsequent reduction in capital tax gains rates would fetch government revenue down from Rs 7,000 (Rs 70 billion) to Rs 1,000 (Rs 10 billion).
c) Though the government might have introduced STT with a view to collect tax which otherwise have been evaded. This might encourage more speculation in the stock market rather than investment for long-term capital appreciation.
d) There are numerous occasions when stock market scams have been unearthed. Since 1992 the era of the Big Bull Harshad Mehta to Ketan (K-10) Parekh, these situations provided opportunity for people to speculate and take advantage to bring volatility in stock market and in share prices irrespective of strong fundamentals both from the company perspective and economic conditions.
e) B.G Shirsat (2001) & Rishi Chopra (2001) Compared with several leading international financial markets, the volume of speculative trading in Indian markets is extremely high. Accordingly Indian financial market are placed second to NASDAQ in speculation, thereby surpassing some of the leading financial markets such as New York Stock Exchange, London Stock Exchange, Singapore, Hong Kong Stock Exchange and Japan.
f) Another category of investors who might possibly take advantage of the new modified tax is Foreign Institutional Investors (FII’s), which may create more volatility and risk in the market. This is due to the fact that previously they are required to pay 30 percent tax on short-term capital gains and 10 percent long-term capital gains. But with the existence of Double Tax Avoidance Agreement (DTAA) between India and Mauritius for the last 22 years, FIIs whether individuals or companies residents of Mauritius are required to pay tax only in Mauritius and not in India. On the other hand in Mauritius, there is not capital gains tax. The FII’s for compliance with the tax laws of Mauritius need to file return, which is just a simple paper work.
g) The investment of FIIs in debt funds has also been raised from existing $1 billion to $1.75 billion.
h) The question is why does the government gives more importance to FIIs considering the huge foreign exchange reserves which can be utilised for development purposes. SEBI Annual Report (2001-02) Table III gives details of the yearly trends of FII Investment in India

TABLE III

YEARLY TRENDS IN FII INVESTMENT