Raising STT: To Do Or Not To Do!

By: Pankhuri Sharma, 4th Year, Dr. Ram Manohar Lohiya National Law University

Introduction

Recently, the report submitted by the Parthsarathy Shome Committee has recommended that the short term capital gains tax on securities should be abolished and to make up the loss, the Securities Transaction Tax (STT) charged on sale and purchase of equities in the stock markets should be raised. Though the Finance Minister, Mr. P Chidambaram has still not made his mind on this recommendation and hence, such increment is a bit away from execution, the disturbance created by the recommendation can be felt in the market. The purpose of writing this piece is to weigh the pros and cons of the raised STT.

Securities Transaction Tax

The Securities Transaction Tax was introduced in the Union Budget of the 2004-2005 by the Finance Minister, Mr. P Chidambaram and came into effect from the assessment year 2005-06. As the name suggests, it is the tax on the transaction of the securities.  The definition of securities is nowhere given in the Income Tax Act, 1961. However, the Explanation 2 of clause (42A) of Section 2 the Act refers to the clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 for the same, which says :-
(h) "securities" include—
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
(ia) derivative;
(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;
(ic) security receipt as defined in clause (zg) of section 2 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
(id) units or any other such instrument issued to the investors under any mutual fund scheme;
(ii) Government securities;
(iia) such other instruments as may be declared by the Central Government to be securities; and (iii) rights or interest in securities;

Thus, Securities Transaction Tax is charged on the transactions of equity shares, derivatives and sale of units of equity-oriented funds entered in a recognized stock exchange. Before the introduction of Securities Transaction Tax, the profit on sale of different securities was calculated in different ways, dependent upon the period of holding of such securities. However, the STT is levied on every such transaction, irrespective of it being a profitable one or one that resulted in a loss.

The Report on General Anti Avoidance Rules (GAAR), 2012 submitted by the Expert Committee on General Anti Avoidance Rules has recommended that the Government should abolish the tax on gains arising from transfer of listed securities, whether in the nature of capital gains or business income, to both residents as well as non-residents. In order to make the proposal tax neutral, the Government may consider to increase the rate of Securities Transaction Tax (STT) appropriately.

Pros of the Recommendation

As the STT is levied on every transaction on listed securities,  it is not only easy-to-administer but also is seen as being capable of  combating with the problem of round tripping and treaty shopping of tax treaties, especially in the case of  Mauritius DTAA.  This is so, because due to the benefit of DTAA the residents of such tax havens are exempt from paying capital gains tax in India (and also in the country they are investing from). But they need to pay STT in spite of such treaties. Hence, if the rate of STT is raised to substitute the short term capital gains tax (long term capital gains tax is already exempted under clause (38) of Section 10 of the Income Tax Act), then the Indian Government would not be needed to make cumbersome efforts to rework the India-Mauritius DTAA through the Joint working group comprising of officials of both countries. Also, since the brokers have to mechanically add this tax to the transaction price, there is no question of declaring or hiding the profit, as done in the cases of capital gains tax.

Moreover, as the Shome Committee pointed out, the abolition of tax on portfolio investment may encourage fund managers to shift their bases to India. As a significant outcome of the present tax regime, fund managers of foreign investors do not base themselves in India because the presence of fund managers would constitute permanent establishment of such investors in India and hence they would be liable to the taxation on business income, whose present rate is 30%.

Last but not the least, in the present times when the collection of STT has been dipping over, reflecting the negative market sentiment, the recommendation to abolish the tax on gains arising from transfer of listed securities to both residents as well as non-residents, can be seen as the  needed step from the Government to revive the faith of the investors.

Cons of the Recommendation

Firstly, as the STT is not charged on profit but on the transaction itself, the retail investors and arbitrageurs would be under the probability of suffering the loss. Also, the frequent traders would be deterred from making transactions as they need to pay on every sale or purchase, irrespective of the loss incurred.

Secondly, the STT rate in India is already highest in the world.  India is also among the rare countries which impose both stamp duty as well as the STT on equity transactions. In 2011, the Securities and Exchange Board of India (SEBI) chief Mr. U K Sinha expressed his concerns regarding such high rates and hoped a cut in it. The former Finance Minister, Mr. Pranab Mukherjee reduced the STT by 20% on delivery transactions from 0.125% to 0.10% in the Union Budget 2012-13.

Thirdly, even if the long term fallouts of the STT – reduction in liquidity of the market and migration of volumes across markets and borders – are let alone, the raised STT poses an immediate risk of foreign institutional investors migrating to other markets with lower transaction cost. This is so because around 38 % of FDI flows in India via Mauritius route and 10% via Singapore route, in which the investors don’t need to pay capital gains tax at all. In such a case, the STT raised to the level of substituting the short term capital gains tax would make the investor pay as much as he would have paid without the benefit granted by these treaties. This would render the treaties, which have been source of about 50 % FDI in India, redundant.  The question is that if the Government thinks it can afford such situation right now, what is the point of delaying GAAR at all?

Conclusion

The Parthsarathy Shome has invited the comments of the stakeholders on the report. Though, the market sentiments reflected till now appear to be varied and SEBI since last year is suggesting to scrap the STT in totality, Finance Minister as of now has said, that he would take advice of the tax administrators who would study the upside and downside of the recommendations. Even if the recommendation is accepted, it has to be seen that what would be the rate of increment in already notoriously high STT to overcome the abolishment of short term capital gains tax which is right now charged at 15%.

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