Sebi writes to govt urging tax parity between cash and derivatives

Differentiating tax structure incentivising participation in the derivatives segment, Sebi tells government

The Securities and Exchange Board of India (Sebi) intends to have tax parity in the futures and options (F&O) segment. Sebi is of the view that the differentiating tax structure, particularly the securities transaction tax (STT), is incentivising participation in the derivatives segment.

The market regulator has written to the government—which sets the tax rate for the capital market—on bringing tax parity between the cash and the derivatives segment.

Currently, a STT between 0.1 per cent and 0.125 per cent is levied on F&O transactions. Within the derivatives segment, STT on sale of options—the most-popular segment—is just 0.05 per cent (if the contract is not exercised). On the other hand, STT is charged at a much higher rate of 0.1 per cent for delivery-based trades in the cash segment

“Sebi has been making efforts to discourage retail investors from participating in the derivatives since these are sophisticated instruments and if investors with inadequate knowledge stand at risk of losing lot of money.  Favourable tax treatment among other factors is encouraging small time investors towards derivative markets. Hence, the regulator has requested government to consider ending the tax arbitrage,” said a source.

Relatively favorable tax structure and availability of higher leveraging has increased the popularity of the derivatives market vis-à-vis the cash segment. The average daily turnover in the F&O segment is nearly four times higher than the cash turnover.

While the derivatives market was introduced for hedging, a lot of investors use it for trading purposes. Experts believe tweaking the tax structure should consider the nature of the trade. “The regulators should not apply a blanket rule for taxing the derivative transactions. There should be a rationale mechanism to determine the purpose of trade and higher levies should be applied where the investors have used the platform purely for speculative purposes,” said Sandeep Parekh, founder, Finsec Law Advisors.

In the past, the government has used increased tax levy as a tool to discourage investors from certain segments. The centre increased the STT on options transactions from 0.017 per cent to 0.05 per cent in the Union Budget 2016-17 to discourage concentration of volumes around options.

Sebi’s letter to the government comes amid a slew of measures around the derivatives market. The market regulator has expressed its reservations over excessive retail investor participation in the futures market. The section contributes to roughly 20 per cent of the total volumes in the derivatives markets.

“Tightening the derivative framework for retail investors was needed since a lot of individual investors were using the platform for trading rather than hedging purposes. The F&O markets are extremely sophisticated and retail investors stand at risk of losing significant capital if the calls go wrong,” said Deven Choksey, managing director, KR Choksey Investment Advisors.

During the last board meeting, Sebi had made physical settlement of shares mandatory. Until now all transactions were cash settled.  The market regulator introduced the concept of ‘product suitability’ according to which an investor can take restriction free exposure to derivatives only up to certain threshold, to be determined by his income levels.  

Sebi also asked the brokerages to collect additional margin money in form of exposure margin.