With the Budget 2013 round the corner, markets are once again speculating (similar to last year) that the government is considering changes in the rate of Securities Transaction Tax (STT).
The justification being given is that the reduced costs on security transactions will help to broaden the market participation.
The context appears to be persistent with weak market sentiments over the last year (except for last month), global economic concerns and loss of foreign investors' confidence in the economy.
STT was first introduced in 2004 by the then (and current) finance minister P Chidambaram by abolishing tax on long-term capital gains and reducing short-term capital gains tax rate to 10% on transactions in securities.
Several reasons were given in support of such change - that unlike the capital gains tax on transfer of securities, the STT is much easier to implement as collections of taxes will be through the stock brokers at the point of execution of transaction and transmitted centrally through exchanges.
STT was also targeted at foreign institutional investors (FIIs) investing via the Mauritius route and seeking to claim benefit under the tax treaty that India has entered with it. STT would pave the way to collect some taxes from such FIIs as well.
This apart, STT was expected to dampen the furious speculative activity on stock exchanges by day traders and arbitragers, thereby making Indian financial markets less volatile and more efficient. Further, abolition of long-term capital gains would promote investments in the capital market from foreign and retail investors in India.
The STT rates have been marginally revised over the years but still remain broadly in the same range. In an attempt to boost investor sentiments, the Finance Act 2012 has made 20% reduction in STT on delivery-based transactions. There has been no change in STT on derivatives transactions.
Considering the macro-economic outlook, weak investment activity and to ensure adequate liquidity in the system, STT on equity transactions needs to be significantly reduced and withdrawn for derivative transaction.
Withdrawal of STT on derivative is justified - as unlike investors who take delivery; those who trade derivatives churn their trades many times during the day. They play for smaller profits at greater volumes and frequencies. The proportion of STT as part of their profit is, therefore, quite significant.
Globally, stock exchanges impose securities transaction tax or duties on equity-based transactions. But most exchanges shy away from imposing any transaction tax on derivative transactions.
The Indian experience has also been that volumes in both cash and derivative segment on the exchanges have suffered once STT was imposed. STT has made equity segment less viable for brokers involved in jobbing and arbitrage trade and they have shifted to the commodity segment, where no such tax is applicable and is therefore more lucrative.
Detailed study needs to be undertaken by FM to isolate the impact of STT on the current state of stock markets. Any move to reduce STT or to simply abolish should be made by FM only after weighing the intent of introducing it and prevailing macro-economic situation and fiscal deficit of India including the taxes collected through STT route.
(The author is partner, Deloitte Haskins & Sells. The views expressed are personal)