The stock market reaction over Parthasarathi Shome’s recommendations was not only too small but also short-lived as it barely lasted for an hour. After opening marginally higher, key indices slipped lower, which is not in line with what most experts expected after the committee proposed the postponement of GAAR (General Anti-Avoidance Rules).
The GAAR can is now being pushed far into the future where a new government will have to take the call after it gets elected in 2014. There is a possibility that GAAR may never see the light of day given that it was already pushed back once earlier after the Budget announcement by then Finance Minister Pranab Mukherjee. Given the reception it received both within the investing and political community, GAAR in the current form might not be a welcome proposal.
Though the market had factored in a postponement and low to nil impact on stock transactions, there are other recommendations by the committee that have disturbed the party. There is no long term capital gains tax on transactions where the securities transaction tax (STT) is paid for both resident and non-resident taxpayers, and a 15 per cent short-term capital gains tax. The Shome committee has proposed abolition of even the short-term capital gains tax.
Even domestic traders for whom trading in listed stocks becomes business income will be exempt from paying tax on portfolio income. But in order to compensate this loss on capital gains tax, Shome committee has recommended an increase in STT.
The logic behind doing this is to encourage portfolio investments in the country by both global and domestic fund houses. But by doing this the committee is asking the retail investors and arbitrageurs to bear the cost. While capital gains tax is imposed only in case of a “gain” or profit on the transaction if it is sold or squared off within a year, STT is a tax levied on every transaction, irrespective of it being a profitable one or one that resulted in a loss. Further, STT is levied on the gross amount traded and not on the profit or loss incurred, making the tax a big deterrent for frequent traders.
As per National Stock Exchange, India is one of the costliest destinations to trade. STT, along with other taxes, and high brokerage structure makes trading in India almost five-six times higher than in advanced countries.
Most of the daily volumes on the bourses are by retail participants and arbitrageurs (who take advantage of price differences between the various exchanges and derivative instruments). High transaction costs and the opportunity of leverage have caused investors to move from cash markets to derivatives markets. Most of the institutional players buy or sell in the cash market and take a hedge (in case they have the underlying shares) in the derivatives market. The cash markets account for less than 10% of the volume on BSE and NSE. Thus, individuals, retail investors and arbitrageurs will thus be subsidising to loss of capital gains tax.
The role of arbitrageurs and retail investors in the market has never been appreciated by the government. These market participants bring in the much desired and the least understood element of liquidity. But for this, impact cost of buying or selling a share would make it prohibitive for an investor to enter and more importantly exit a market with ease.
Increasing STT will suck out liquidity from the system. This poses a bigger problem: unless an investor is able to get out of a share at any point of time, he will be least interested in getting in.
