Pros & Cons of CTT

By: Pankhuri Sharma, IVth Year, Dr. Ram Manohar Lohiya National Law University

According to media reports, the Finance Ministry is likely to introduce  commodity transaction tax (CTT) of 0.018-0.125 per cent on all non-agro commodity trades like metals and crude oil in the approaching Budget on 28th February, 2013. However, many market players including the five top commodity exchanges - MCX, NCDEX, NMCE, Indian Commodity Exchange and Ace Commodity exchange, Ministry of Consumer Affairs, Food and Public Distribution are opposing any proposal to levy CTT. The purpose of writing this piece is to weigh the pros and cons of CTT, if introduced in this session.

What is CTT

The CTT was introduced in the Union Budget of the 2008-09 by the Finance Minister, Mr. P Chidambaram , but was not implemented due to opposition by traders, brokers and commodity exchanges. As the name suggests, it is the tax on the transaction of the commodities. The Finance Act, 2008 specified the taxable commodities transactions, rates and the party liable to pay the CTT, as given in the following table.

Section 2 of Forward Contracts (Regulation) Act, 1952 defines “option in goods” as an agreement, by whatever name called, for the purchase or sale of a right to buy or sell, or a right to buy and sell, goods in future and includes a teji, a mandi,  a teji-mandi, a igalli, a put, a call or a put, and call in goods.

In Shree Capital Services Ltd. v. ACIT [1], accepted the definition of the term "derivative" given by SEBI, which reads as under :-

"The term "Derivative" indicates that it has no independent value, i.e. its value is entirely derived from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre-determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities."

While appreciating this debate on CTT, one should also keep in mind that government is likely to impose CTT on all non-agro commodity trades such as metals and crude oil. Ideally, policy they should not discriminate among different kinds of commodities only because non-farm commodities have higher volumes, as this is against the basic norm of tax jurisprudence which provides for “horizontal equity”.

But the other line of thought says that as non -farm commodities comprise more than  80 per cent of all commodity futures transactions, the element of speculation as opposed to hedging is significantly large in these commodities and hence should be liable to CTT.

Pros of CTT

The basic rationale which is given behind introduction of the transaction taxes is basically to ensure the reporting of the transaction and keeping check on the tax avoidance. But every commodity transaction requires a unique client code and PAN, and attracts service tax and stamp duty. Besides that all such transactions are reported to the Forward Markets Commission and the Income Tax department. So, there is already a fairly good mechanism to keep check on tax avoidance. The other rationale for introduction of transaction tax is that it is expected to reduce guesswork and unpredictability, and help markets discover efficient prices.

However, the main rationale given for the introduction of CTT this time is that as Securities Transaction Tax (STT) is levied on derivatives on equities, a level-playing field should be provided by introducing transaction taxes on derivatives instruments on commodities.

The argument taken by Stock exchanges and banks, in favour of levying CTT is based on two factors. Firstly, as all derivatives are treated as financial instruments, irrespective of the underlying asset from which they derive their value, there is no reason for taxing derivates on bonds and equity different than derivatives on commodities. Secondly, it is also alleged that because of the STT charged on transaction of securities, the investors are giving more preference to the commodities markets to the equity markets. Rakesh Somani, President, Association of NSE Members of India, says, "How markets are taken over by the commodities market or we have even made a comparison of Nifty being traded in Singapore. What we are trying to do is tell the government that one of the major market components we had was arbitrageurs and jobbers. They have already shifted to commodity market. So, the major volumes has already gone their". [2]

Cons of CTT

The foremost concern of the commodity exchanges are that CTT on commodity derivatives could increase the cost of hedging transactions. Hedging is undoubtedly an integral part of the commodities market where investors seek to insure their physical trades from price fluctuations by selling or buying products in futures, options, and over the counter derivatives in accordance with the “reference prices”. Transaction tax would not only increase the cost of hedging but also drive out genuine hedgers as efficiency of hedging platform is an inverse function of the cost of transacting on it. Not only this, the increased cost of transaction would reduce the short term transactions which would adversely affect the income. Moreover, commodity market is already disadvantaged by issues like absence of tax exemption on business income & capital gains and limited participation. The median tax on the commodities traded is at 19.55 per cent, which is very high.

Secondly, it should be understood that the while the basic purpose of equity trade is capital appreciation, commodity markets help investors in price discovery and risk management. Hence, both should not be compared.  This is so, as in stock exchanges investors seek to gain from price boosts, whereas in commodity exchanges functionaries seek to insure their physical trades from price fluctuations.

Thirdly, the main reason due to which CTT was not implemented in 2008-09 still subsists. In 2009, the Prime Minister's Economic Advisory Council (PMEAC) opposed levying transaction tax on commodities trading saying that such implementation put lakhs of jobs and livelihood in the entire commodities market at stake. For example, like hedging, speculation is an integral part of commodity trading. It involves permanent speculators like day traders such as jobbers, swing traders, etc who play a crucial economic role in reducing the transaction costs by keeping the bid-ask price spreads low. They trade on subtle intra-day price fluctuations, intra-day price trends and on bid-ask price spreads, and close their positions at the end of the day.

To keep transaction costs in such markets as low as possible and hence, maintain the liquidity , it is important to make sure the presence of a large number of permanent speculators, so that more competition among them would bring down the bid-ask spreads. But as CTT will add to such costs, the involvement of such active day traders would reduce their involvement, affecting their jobs as well as commodity derivatives market.

Fourthly, CTT could lead the commodity derivatives trade, which has created over million jobs in the country in the last decade, to move to much more liberal offshore exchanges or to ‘dabba’ which is a colloquial term used for off-market, informal trade activities, which are illegal in nature and where punters indulge in speculative trading to make quick money without paying any taxes or other transaction fees.

Conclusion

The debate of reintroducing CTT has been initiated by stock exchanges for bringing parity between commodity transactions and equity transactions as latter are charged with STT. Not even taking the argument that both of them shouldn’t be compared, the author wishes to point the fact that the continuance of STT itself can’t be ensured. Though till now, the Finance Ministry has neither shown its inclination towards Shome Committee Report which recommended raise in STT in lieu of short term capital gains tax nor towards various market players who have been recommending abolition of STT for long time, it is speculated that Finance Minister may reduce or abolish STT in this budget. Therefore, it doesn’t seem logical to ask for implementation of CTT on basis of STT. [3]

Also, it should be understood that the overall market mood is almost similar to as it was in 2008-09. Though the volume of commodity transactions has increased and  new exchanges have come into picture in these 5 years  but there is no substantiation of the fact that benefit of futures trading actually flowing to the intended stakeholders. Hence, how can government think of generating more revenue by imposing CTT when the net revenue outcome would be negative, bearing in mind its adverse impact on income-tax collection from commodity traders, day traders, commodity exchanges, and other dependent people, whose incomes will inescapably fall.

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[1] ITA No. 1294 (Kol) of 2008
[2] Budget 2013-14: Brokers request Finance Minister to rejig Securities Transaction Tax, , last accessed on 22 Feb 2013  http://ibnlive.in.com/news/budget-201314--brokers-request-finance-minister-to-rejig-securities-transaction-tax/373780-7-255.html
[3] Indian Express, Commodity Transaction Tax: Bourses fear Rs 150 lakh crore business loss to dabba trade, last accessed on 22 Feb 2013 http://articles.economictimes.indiatimes.com/2012-02-12/news/31052232_1_commodity-transaction-tax-commodity-market-dabba-market