Diluting the Tax

Under pressure from powerful lobby of brokers, speculators, arbitrageurs and “noise traders,” Finance Minister, P. Chidambaram, diluted several important provisions of the proposed securities transaction tax (STT). For a detailed analysis of the proposed STT, see Kavaljit Singh, Equitable Equity: India Introduces Securities Transaction Tax, at this website).

It is important to note that Finance Minister has not only reduced the tax rates but also offered differential tax rates for different market players. In an announcement in the Parliament on July 21, 2004, he announced following amendments in the proposed STT regime:

1. The 0.15 per cent STT would only be applicable on delivery-based trade in equity.

2. The 0.15 per cent STT on delivery-based trading would be equally split between the buyer and the seller.

3. The STT rate for day traders, arbitrageurs and “noise traders” has been reduced to a meager 0.015 per cent. Further, they would be allowed to take credit for the tax against business tax on profits.

4. The STT rate for derivative traders has been reduced to 0.010 per cent and they too would be allowed to take credit for the tax against business tax on profits.

5. Trading in bonds, including Government bonds, would be completely exempted from STT. In the same vein, units of mutual funds (other than equity-oriented funds) would also be exempted from STT.

Soon after amendments in the proposed STT regime were announced, speculators and day traders got active in the markets and as a result the stock indexes witnessed a massive surge within few minutes. The reason being that such a massive dilution of tax regime was way beyond the expectations of day-traders, speculators and other market players. By diluting several provisions of the proposed STT regime, Finance Minister has not only bowed to pressure from this powerful lobby but also given a clear signal that the new government is fully subservient to the private interests of speculators and day traders. No wonder, Finance Minister, who was hounded for introducing the STT, became the darling of such market players soon after the announcement.

The major gainers of the revised STT proposals are speculators, day traders, brokers, arbitrageurs and derivative traders who indulge in large-scale speculative activity in the financial markets. Such a preferential tax treatment to this community has legitimized their undesirable speculative activities in the Indian financial markets.

What is distressing is that genuine investors who carry out delivery-based transactions have been penalized with higher taxation. Instead of taming speculative activities in the financial markets which diverts large amounts of resources away from productive purposes, genuine investors have been penalized. No explanation has been given for unfair treatment to genuine investors.

It is a well-established fact that the depth of financial markets is determined by the number of genuine investors (not speculators) it is able to attract. It is the genuine investors (not speculators) who are the life and blood of the financial markets. Particularly in the case of India where deliveries are less than 20 per cent of trading volume, higher taxation on delivery-based transactions would act as a disincentive for genuine investors. By doing so, Finance Minister has offered unfair disadvantage to genuine investors. India is perhaps the only country in the world that punishes genuine investors by imposing higher tax rates.

One of the biggest losers of the proposed amendments would be the government itself, as there would a revenue loss of at least Rs.25000 million. No one knows how the government would fill this revenue loss.

What is even more distressing is that Finance Minister has not shown similar flexibility on his controversial proposal to increase the limits of foreign direct investment on insurance, telecommunications and civil aviation sectors. The proposed hike in foreign investment in these sectors is strongly opposed by the left political parties, which are supporting the Congress-led United Progressive Alliance (UPA) government. It appears that Finance Minister is more submissive to the private interests of speculators rather than its political allies.

With the proposed amendments, Finance Minister has lost a golden opportunity to curb excessive speculation in the Indian financial markets. Now it is very clear that the STT is not meant to curb excessive speculation or raise revenues.

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