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Turnover tax: FM 'hai naa'!

Jul 21, 2004

The much-awaited clarification on the controversial issue of turnover tax on securities transactions (introduced in the budget) has finally been made. Finance Minister (FM), Mr. P. Chidambaram, just a short while ago, announced the revisions pertaining to the turnover tax, which were given a thumbs up by India stock markets as they gained sharply (nearly 2%) in the last 15 minutes of trade, albeit closing at pared levels due to closing hour index level adjustments. It must be noted that the FM had imposed a turnover tax of 0.15% on the transaction value of securities in his Budget, which was valid across investor categories. However, the revised announcements made by the FM today are:

The FM has maintained status quo on transaction tax for delivery based trades i.e. delivery based trades will continue to be charged @ 0.15% of the transaction value as tax. However, the change here is that unlike what was announced in the Budget, that the transaction tax would be charged at the rate applicable "only" to the buyer, this has now been "split equally" between the buyer and the seller. Thus effectively, this means that both these parties to the transaction will now bear 0.075% of the transaction value. The impact of this announcement on long-term investors, basically, remains unaltered, though the immediate burden of transaction tax is reduced by half.

The transaction tax for trades by day traders and/or arbitrageurs (non-delivery based) has been revised sharply downwards to 0.015% of the transaction value (one-tenth of that announced in the Budget). The impact of this was clearly visible on the stock markets today with the indices gaining sharply in the closing minutes of trade. This is because, with this announcement, the FM has put to rest the concerns about liquidity drying up on the bourses owing to lack of participation by day traders and arbitrageurs, which constitute nearly 3/4th of the daily turnover on the bourses. Further, for this category of investors, if the income arising from trading and arbitrage is considered as business income, then the transaction tax paid earlier will be allowed as credit/set-off against their normal income/corporate tax.

As far as the trades on the derivatives segment is concerned, the Futures and Options segment will now be subject to a reduced 0.01% transaction tax, which is again a welcome step for the volumes of this segment of the markets.

The FM has also removed the debt market trades from the purview of the transaction tax. This is a positive for the debt market, as this segment operates on wafer thin margins (about 0.05%) and as such a 0.15% transaction tax would have sounded a death knell for them.

Apart from these turnover tax related issues, the FM has redefined mutual fund units as securities and hence these units will now have the capital gains benefits announced in the budget. It must be noted that the FM was silent on the capital gains benefit for the mutual fund industry thus implying that only direct investments into equities would be eligible for capital gains benefits. However, with this announcement today, not only the mutual fund industry but also the mutual fund investors would have given a sigh of relief as they are now at par with direct equity investments.

Amongst all this, it must be noted that the FM maintaining status quo over short-term capital gains tax, which were lowered sharply to 10% in this years Budget, is a welcome boost for the Indian stock markets. There were apprehensions that in order to meet the shortfall from the lowering of the turnover tax, the FM might resort to raising the short-term capital gains tax. Thus, to conclude, the FM has not only resolved this entire turnover tax issue, it has also arrived as a win-win situation for all the market participants.

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