India's Transaction
Tax
Disproves All Fears
By Kavaljit Singh
06 November, 2004
Znet
On October 1, 2004, the Securities Transaction
Tax (STT) came into implementation in the Indian financial markets.
The market players and analysts who had predicted that the introduction
of STT would bring Indian financial markets to a standstill have been
proved completely wrong. On the first day of the implementation of the
STT, not only the Sensex (Indias most popular stock index) witnessed
an increase of 91.93 points (highest since the introduction of STT was
announced by Finance Minister in July 2004) but the Indian authorities
also collected over Rs. 50 million in tax revenue. It has been estimated
that based on existing trading volumes in the Indian financial markets,
authorities would be collecting sizeable revenue of Rs 15000 million
on an annual basis. This is not a small amount in the present times
when tax revenues are under severe pressure. Now over a month has passed
since the implementation of the STT, the apprehension of market players
and financial media that it would drive out large financial transactions
from Indian financial markets has been unfounded.
Often termed as
Terminator Tax, the STT was strongly opposed by a lobby
of speculators, day traders, arbitrageurs, and noise traders.
When the Finance Minister announced the introduction of STT in the Finance
Bill on July 8, 2004, this lobby launched an impromptu agitation against
the proposed tax. Largely under the pressure of this powerful lobby,
Finance Minister had to dilute several key components of his earlier
tax proposal. (For details, see my articles, Equitable Equity:
India Introduces Securities Transaction Tax and Bonanza
for Speculators: Securities Transaction Tax Turned Over at this
website). Under the revised tax regime, investors are liable to pay
a 0.15 per cent STT on any delivery-based equity transaction carried
out in a recognized stock exchange, to be shared equally between buyer
and seller. In case of non-delivery transactions, the STT would be levied
at 0.015 per cent, to be payable by the seller.
Going by the trading
pattern in the equity markets, it is very clear that the STT had no
significant negative impact. Till now, there have been no technical
snags in the implementation of the STT as much feared. The tax is collected
by the stock exchanges from the brokers and passed on to the exchequer,
thereby enabling the authorities to raise revenue in a neat and efficient
manner.
Despite the fact
that delivery-based transactions have been taxed under the STT, the
trading pattern reveals that the ratio of deliveries to total volumes
has improved (not declined) since its implementation. Another apprehension
of the opponents that STT would dry up liquidity in the markets has
also proved erroneous. On the contrary, there is too much liquidity
in the markets, the fact also admitted by the opponents of the tax.
In addition, the
implementation of STT has reduced several loopholes in the existing
tax regime. For instance, foreign investors who used to take undue advantage
of the bilateral direct tax avoidance treaties would now be taxed under
the STT regime.
If viewed in the
context of raising tax revenue, the opportunities offered by the STT
are enormous, provided the Finance Minister withdraws special concessions
offered to day traders, speculators and brokers. Despite these concessions
and other shortcomings, STT has the potential to bring stability in
the Indian financial markets. While supporting the STT, I also recognize
that all problems related to speculation, volatility and instability
in the Indian financial markets would not be resolved by the STT alone.
In the present times, no single instrument by itself can solve all problems
plaguing the Indian financial markets. If used in conjunction with other
policy mechanisms (such as banning short selling and insider trading),
STT does offer a potent mechanism to deal with the multiple problems.
However, recent
media reports suggest that the Indian government is considering several
proposals to further dilute the provisions of the STT. In particular,
what is disturbing to note that the government is considering complete
exemption from the STT for securities traded in the soon to be launched
International Financial Centres (IFCs), as part of Special Economic
Zones (SEZs). In essence, the IFCs are expected to become offshore financial
centers, offering all kinds of financial services including offshore
banking, stock trading and commodity trading to both domestic and foreign
investors. Although the IFCs are to be located within the territory
of India but existing tax, labor and other regulations would not be
applicable to entities located in it. Thus, investors would not be subjected
to the STT and capital gains tax if transactions are conducted through
IFCs.
This is an issue
with serious implications on the Indian financial, tax and regulatory
system. Unfortunately, this issue has not received much attention from
the policy, academic and political circles (including the left political
parties which are opposed to present governments financial liberalization
policies). It is high time that this issue is discussed and debated
in the national political arena.