Taxing issue

Lower transaction costs alone won't increase capital market activity

At a recent event marking the 25th anniversary celebrations of the National Stock Exchange, its Managing Director and Chief Executive Officer, Vikram Limaye made a strong pitch for bringing down securities transaction and compliance costs in the Indian market. Investors not only have to submit margin; they have to compute and pay a plethora of taxes, including the securities transaction tax (STT), capital gains tax, stamp duty and the goods and services tax, on every capital market transaction. In addition, companies must pay a dividend distribution tax if dividend is paid. 

Mr Limaye’s point is that all this makes India’s capital markets less competitive compared to its peers, and hence less attractive and less liquid. In turn, that means less investment flows into the Indian economy, thereby constricting the ability of businesses to raise financing. In comparative terms, investors do need to cope with far lower taxes and much less in the way of compliance costs in other markets. There is certainly a case for streamlining the tax regime, and for cutting rates. There would undoubtedly be more investment in Indian financial assets if the overall transaction costs were reduced. This would indeed make it easier for investors to enter the capital market, and that would facilitate companies in making public offers to raise funds. 

The government’s case for continuing to impose this basket of taxes is simple enough. Most of these are levied at source and automatically collected whenever there is a transaction. Moreover, during the current economic downturn, where tax collections are running well behind Budget estimates, the government would be reluctant to forego any source of revenue. There would also be complications involved in attempting to reduce or simplify several of the applicable taxes. For example, while the STT and the capital gains tax are specific to the capital markets and apply nationally, the stamp duty payable is specific to the state of residence. Hence, there is a political angle and states would have to be persuaded to forego stamp duty, or to reduce the rates. In the case of GST, the GST Council, which includes states, would have to be convinced that it makes economic sense to reduce the applicable rate on capital market transactions. There is also the point that tinkering with GST rates to offer sector-specific relief sets a bad precedent. Such tinkering has already led to a more convoluted GST. 

There is another point. Investments track earnings and the promise of profits. While ease of transaction and low costs are both important factors in attracting investments, the ultimate magnet is earnings growth. India has seen five successive quarters of slowing growth and earnings downgrade. Under the circumstances, it is no surprise that investors have been cautious and transaction volumes have reduced. A streamlining of the tax regime would certainly be desirable. Indeed, there is a case for tax reform across the board; not just in the narrow sphere of financial markets. But in itself, lower transaction costs might not be enough to trigger higher trading volumes in capital markets. For that, a turnaround in the economic cycle is required.