The Hindu : Business : Recognising the market structure

Online edition of India's National Newspaper
Saturday, Jul 24, 2004

Business

Business

Recognising the market structure

By C. R. L. Narasimhan

The Securities Transaction Tax (STT), introduced for the first time in the recent budget, has become the first major proposal to be substantially modified. There would be other concessions/modifications when the Finance bill is moved but it is unlikely that any of them would have the same significance as that of the revamped STT has had. The Finance Minister has moved swiftly to mollify the stock market, which had responded negatively to the new tax. In fact on the budget day, the unanimous opinion was that the STT almost single-handedly turned the sentiment against the budget. The stock prices dropped by more than 100 points.

Market concerns

This time, unlike on several occasions in the recent past, the UPA Government had to heed the stock market concerns. So comprehensive was the criticism of the new tax, with plenty coming from areas not even remotely linked to the stock market, the Finance Minister had to act fast. The market's reaction was just one of the worries. The fact that two important segments of the capital market — the debt market and the day traders — practically shut down probably clinched the issue. In the end, it was not merely a question of making a new tax palatable but of understanding the business of the prospective taxpayers. The debt segment, trading at very thin margins, could not have borne the tax in the first place. But sadly those who framed the tax were totally ignorant of this and other basic facts of the capital market's working.

The modified tax proposals make a complete break what was originally proposed. The STT as a concept has not been abandoned and this by itself is a victory of sorts for the Government. In place of the original 15 basis points tax on all segments, cash, futures covering debt and equity, the modified structure puts in place a differential turnover tax regime.

Two intermediaries

Most importantly, it recognises the principle that there are two sets of intermediaries in the capital market — those who pay capital gains and those who pay taxes on the basis of business income. The right to set off the STT against the tax paid on the business income is given. The reduction in short-term capital gains and the abolition of long-term capital gains continue. The stock markets reacted favourably to the new tax proposals.

The Sensex gained more than 80 points on Thursday, the first trading day after the modifications were announced and closed the week well above the 5000 mark.

The new tax proposals are however not free from criticism. They are by no means simple to understand and implement. Second, they may encourage some unscrupulous share activities. A collusive ramping up of the prices of some illiquid scrip may happen on a large scale. Also, money laundering may become more widespread. Both these practices are possible in a distinctly lower tax regime that will come about.

On the plus side, of course, the STT would be easier to collect than the tax on capital gains that it replaces (at least partially).

The new tax will help in spreading the tax net, as every taxpayer will leave a trail. As for the revenue implications from the STT, one can only make rough calculations .The Finance Ministry had earlier estimated Rs. 7,000 crores on the basis of the earlier proposal.

The actual collections will naturally depend on the turnover figures. In the early days the revised STT helped in increasing volumes in all segments. Even over the short-term, obviously there would be other factors at play.

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