Hike STT in cash segment; abolish capital gains regime?

The Securities Transaction Tax will complete 11 years in Feb 2015, when the Finance Minister presents Modi Government’s first full-fledged budget. And over the last 11 years, STT has evolved into a most efficient tax system from an administrative and collection point of view. STT has done some course correction over the years from the high rates it started with, to moving the tax incidence for options from notional value, to premium for the seller of the option. This move came up in 2008 after the market feedback, but it was the starting point for the success of equity options market. Today Options contribute more in STT revenue as compared to Stock Futures.

Over the last many years, some section of the markets have been crying on the need to rationalize STT if not abolish. The BSE Brokers Forum which met the Minister of State – Finance, Jayant Sinha on January 16 , asked for either re-store rebate under section 88E, which was withdrawn in AY 2009-10 abolish STT.  Prior to 2008, STT paid was allowed as expense, from sale and purchase amount, for computing capital gains/losses.Section 88E read – “Where the total income of an assessee in a previous year includes any income, chargeable under the head "Profits and gains of business or profession", arising from taxable securities transactions, he shall be entitled to a deduction, from the amount of income-tax on such income arising from such transactions, computed in the manner provided in sub-section (2), of an amount equal to the securities transaction tax paid by him in respect of the taxable securities transactions entered into in the course of his business during that previous year.”

The argument made by the BSE Brokers forum is that this will help retail and small investors. I would disagree with this argument, that’s another debate. But, before that, the reason government withdrew this benefit was because the market (read brokers) was misusing STT benefit by transferring the benefit to other accounts. This loophole has been addressed by the capital market regulator SEBI since then, by making it impossible for any broker to modify client codes to transfer benefits of STT.  The re-introduction of the 88E is likely to cause loss to the exchequer of around Rs 1000 cr. (But, how to recover this loss, little later).The STT stats:After nearly many years, the government is all set to meet STT targets. The government set itself a target of Rs 5991 cr for FY15. With three months of the current financial year still left, the government is likely to exceed the target by around Rs 400 crores. STT revenue receipt may end the year with Rs 6400 cr.2012-13 (A): Rs 4996.86 cr2013-14 (RE): Rs 5497 cr2014-15 (BE); Rs 5991 cr2014-15 (Apr-Dec): Rs 4940 crCapital gains vs STT?While the Revenue receipts disclosure is silent on how much money does the government get from capital gains from equity capital markets, the estimate is, it is likely to be in very low hundreds. The Capital tax regime for the markets also underwent changes. In 2004, when STT was introduced, short term capital gains was reduced to 10 percent  and long term capital gains was reduced to ZERO. A few year back, the short term capital gains was raised to 15 percent when STT was further rationalized for delivery based buying/selling.So is it time to relook at the capital gains regime?The answer to this question lies in how the market infrastructure and structure has changed today –•         Every investor requires PAN card to access capital market.•         Every retail or small investor who undertakes delivery or non-delivery based transaction is charged STT at source. The administration of this tax is undertaken by the stock exchanges. The cost of monitoring this tax is virtually NIL for the government. •         In June 2013, SEBI introduced the FPI regime. This consolidated the foreign investors (FIIs, sub accounts & QFIs) under uniform KYC regime based on risk perception.What has the government achieved by imposing capital gains?Frankly, government hasn’t been able pinpoint any positives of the capital gains regime in the equity market. Its collections from the equity market is abysmal, foreign investors anyways take advantage of the DTAA to avoid any capital gains. Moreover, the tax department is chasing cases for years on this front without any luck, and worse it hasn’t achieved much success in garnering tax revenues from the domestic market either. And if this is the state of the affair, do we really need a tax for the purpose of having one. Or is it time to do away with capital gains tax from equity market if the government is able to get more than its share from STT without any hassle.Last year, government raised nearly Rs 5500 cr from cash & F&O segment in STT, this year this figure so far stands at Rs 4940 crores for the first 9 months of the Fiscal 2015. So how much does each segment contribute to the STT revenues. In the last two years derivative segment has contributed roughly 20 percent of the total STT receipts. While cash segment has contributed 80 percent of the revenues.                                  2013-14           2014-15*              Equity:                  Rs 4400 cr            3885F&O:                     Rs 1100 cr           1055*Apr-Dec’ 2014 The Long Standing Debate:This has been longest debate against capital gains, and in favour of STT. Should capital gains from capital markets be abolished. This has been for long time a demand by FIIs, who argue that government should do away with capital gains and look at raising STT which is considered as clean, easy to administer and taxed at source. This argument is now being pushed by some of the leading domestic brokerages as well. There is a growing section of the market that wants just one tax for the capital market. They argue that STT could be hiked marginally and Capital Gains should be done away with. A mere 25% hike in STT in cash market (delivery & non-delivery) (Derivative market STT remaining constant) will add nearly Rs 1000-1500 cr to the tax collections of the government. This additional tax revenue will make good any loss from abolishing capital gains and re-introduction of 88E for the markets.Some may argue why should STT be hiked for non-delivery transactions in cash markets. The answer could be a hike in STT would force some of the speculators in the cash market to move to Stock futures & options which hasn’t picked up unlike the Index futures and Options. And further it will increase the cost of speculation in stocks that are not available in the derivative segment. And this speculation has very few takers – neither small investors, brokers, stock exchanges or regulator.