Stock exchanges want commodities, currency and fixed income derivatives
to be taxed in the same way as securities. The stock markets and other
markets serve different economic utility functions: one is for
investments and the second is for price discovery and risk management.
Hence, they cannot be treated the same way. Stock derivatives attract
the Securities Transaction Tax ( STT) but, when the stock exchanges
talk
of a level- playing field, they are fully aware that they enjoy a
special tax treatment under Section 43 ( 5) of the Income Tax (I- T)
Act. Under this section, profits or losses from stock market
transactions are treated as "business" incomes and losses, and are
allowed to be offset against losses or profits from other economic
activities — whether it is real estate, treasury, cement, chemicals and
so on. The same tax treatment applies to currency and fixed income
derivatives ( where there is no STT). The sole stepchild of the special
tax treatment is the commodity derivative segment. Income from commodity
derivative transactions is considered "speculative" income or loss
under Section 73 ( A) of the I- T Act and is taxed up to 33 per cent.
The cash segment of the stock markets also enjoys favourable tax
treatment in that short- term capital gains are taxed at 15 per cent,
while longterm capital gains are tax- free. That is not the case with
the spot markets in commodities, currency and fixed income bonds. If the
turnover at the exchanges and revenue maximisation were to be the
criteria for levying a Commodities Transaction Tax ( CTT), then currency
derivatives stand first in the queue. That is because volumes in
currency derivative trading are $ 57 billion a day compared to $ 12
billion a day for commodities and $ 3 billion aday for fixed income. If,
hypothetically, policy makers want to levy a derivative transaction
tax, they should not discriminate among different derivatives —
commodities, currencies and interest rates. Even among commodities, it
is unfair to discriminate between markets in farm and non- farm
commodities only because non- farm commodities have higher volumes. This
is like saying STT should be levied on Infosys, and not on Suzlon,
because the former has a higher turnover. It will not be fair and
equitable to tax only one segment of any market. That will defeat the "
horizontal equity" principle in the canons of taxation, and will be
construed as the highest level of discrimination. CTT will reduce
liquidity in the market, and widen the bidask price spread. The
commodity derivative market in India provides for the lowest impact cost
(bid- ask spread) in the world, despite the fact that transaction costs
are among the highest. Estimates of the sensitivity of commodity trade
volumes to the prevailing transaction charges levied by exchanges reveal
that a one per cent rise in transaction costs can lead to a 7.8 per
cent decline in volume. The spot- tofutures multiple in India is just 5,
10, 15 compared to global ratios of 20, 30, 50 in agricultural
commodities, energy and metals, which disqualifies the argument of
excessive speculation. As it is, CTT is not levied anywhere in the
world, except Taiwan where volumes have dwindled and moved to Singapore.
Unlike the perception propagated, every commodity trade requires a
unique client code and the permanent account number, and attracts
service tax and stamp duty. In addition, all trades are reported to the
Forward Markets Commission and the I- T department. So, they are 100 per
cent in the tax net anyway. CTT was proposed in Union Budget 2008 and
finally, based on the recommendation of the Prime Minister's Economic
Advisory Council, it was abolished in the Budget of July 2009. In
practice, the tax was never notified and applied. Since the context and
logic have not changed since then, it beats the merit of even a
discussion. Despite this recent history, if the corporate competitive
agenda prevails in policy- making, then the commodity derivatives trade,
which has created 1.5 million jobs in the country in the last decade,
will move to much more liberal offshore exchanges or to illegal,
unregulated dabba ( bucket) shops. That eventuality will only ensure the
corporate competitive agenda of destroying the commodity derivatives
market in the guise of creating a levelplaying field.
Stock
exchanges are instrumental in building capital, and they have been doing
so for over 100 years. The capital raised with the help of the stock
exchanges not only enables and empowers institutions to add to
production and, hence, the country's gross domestic product, but also
leads to job creation. Other organised markets trading derivatives that
do not have transaction taxes have encouraged trading and investment in
non- productive assets, practically reducing the amount of capital
available for investment in productive asset classes like equity. The
fact remains that more retail investor funds are moving to the
commodities markets, instead of finding their way to the equity markets.
The presence of the Securities Transaction Tax ( STT) for equity trades
is acting as a dampener for retail investors to put their money in the
equity markets. This is clear from the turnover data of the stock and
the commodity exchanges reported in Business Standard. The average daily
securities turnover on the stock exchanges has seen a reduction from
Rs. 59,615 crore in the financial year 2007- 08 to Rs. 43,118 crore in
2011- 12, a decline of 27.67 per cent in four years. In contrast, the
average daily turnover in non- agricultural commodities futures has
jumped from Rs. 10,277 crore to Rs. 50,147 crore in the same period,
agrowth of 387.95 per cent! That explains the increasingly vocal demand
from banks, the stock exchanges and market professionals for a level-
playing field between all organised markets if STT cannot be removed. To
provide a level- playing field across all financial derivatives, a
transaction tax should be levied on all kinds of derivatives
instruments, based out of equities, currency, interest rate, commodities
and electricity, to ensure that there is no tax arbitrage that would
encourage traders to move from one asset class to another. Further, the
rate of transaction tax should be uniform to enable fair and just
treatment from a tax standpoint for derivative instruments that could be
used for both hedging, portfolio balancing, trading and speculative
purposes. It is a well- known fact that derivatives on financial
instruments, such as equity or bonds, are similar in nature to
derivatives in commodities. Therefore, in academic literature, all
derivatives are treated as financial instruments, irrespective of the
underlying asset on which they are constructed. In other words, in
concept or in practice, there is no difference between derivatives in
commodities, currencies, interest rates or equities. They are all
financial instruments that are used primarily for speculation or
hedging, so there is no reason for a differential taxation structure.
STT on equities, which is basically an instrument for investment, needs
to be brought down and made the lowest. The transaction tax on futures
should be higher. Options should be even higher. In essence, a new
transaction tax structure needs to be put in place to ensure there is no
tax arbitrage across asset classes. Volumes on the equity markets and
the tax collected by the government have progressively gone down year
after year since the imposition of STT, while the tax- free volumes on
other organised markets, which have become a haven for speculators, have
been mushrooming. If a similar transaction tax is not imposed on other
organised derivatives markets and STT remains – i. e. if any disparity
remains in taxation of other asset classes vis- à- vis securities –past
trends suggest that stock market volumes will go down further and
collections will come down to less than Rs. 1,000 crore in the next two
years compared to the more than Rs. 10,000 crore that can be collected.
People have already started walking away from highly- taxed instruments
like securities, and this process will accelerate. Not imposing
transaction taxes on other organised markets derivatives transactions
will ensure that there is a loss of STT revenue and the transaction tax
revenues the government could have collected, and the collections may
have worked out to be more than Rs. 10,000 crore in a year when the
government is battling a rising fiscal deficit. By not creating a new
transaction tax structure, the government would have successfully
stunted the stock market, propped up speculative trading in other
markets and would not have helped the cause of tax collection either. -
www.business-standard.com