The Hindu Business Line : What's been earned by the unearned

DAY traders and futures and options (F&O) operators have almost been let off from the proposed securities transactions tax (STT). While the former will pay a small 0.015 per cent STT, the latter will pay a still smaller 0.010 per cent as against 0.15 per cent payable by the delivery-based trade in which the buyer and the seller pick up the tabs equally. The day traders and F&O operators can, however, set off the STT against their tax on business income. Thus, for them, practically the old regime continues — only the tax liability would be split between STT and income-tax. This certainly would not rankle. What perhaps would is the unambiguous enunciation by the Finance Minister of the true nature of their income — business.

Any lingering doubt on this score has been squelched. They cannot now clamber into the capital gains bandwagon masquerading as investors if only to get away with a soft 10 per cent tax on short-term capital gains. Tobin tax or STT, which is in vogue in quite a few countries, is not designed to be an alternative to income-tax but an independent impost on share market operators a la excise duty on manufacturers and sales tax on traders.

Just as excise and sales tax are allowed as business expenditure, STT should also have been allowed as expenditure and not as a set off against the income-tax liability. The adverse implications for the Revenue can be explained with an example. Let us say a day trader makes a profit of Rs 1 crore from a volume of purchases of Rs 10 crore. Assuming that he is already in the maximum tax bracket, he will have to pay a tax of Rs 30 lakh ignoring surcharge and education cess. The STT would be a meagre Rs 15,000 which will abate against the tax liability of Rs 30 lakh, thus reducing the effective tax bill to Rs 29.85 lakh. Had the STT been viewed as an expense, as it ought to be, the revenue garnered by the taxman would be Rs 29,95,500.

In the whole exercise, investors have emerged trumps because if they are able to sit tight for one year after acquisition, they can ward off tax liability completely. A small impost of 0.075 per cent by way of STT on purchase as well as on sale of shares would doubtless get the exchequer assured revenue what with the stock exchanges being made responsible, the concomitant abolition of long-term capital gains tax would further exacerbate the inter se inequities between earned and unearned income.

As it is, LTCG from shares is mollycoddled with a soft 10 per cent tax which can be easily and legitimately avoided if only the investor is prepared to lock-up his capital gains in the specified tax shelters.

Now this category of income does not even have to lock up funds in tax shelters — no tax. The small STT which is trotted out as an alternative to tax on LTCG leaves an investor with minor bruises. Here is how. Let us say a man purchases shares for Rs 10 lakh and sells them for Rs 20 lakh a year later. He would pay Rs 1 lakh as tax — 10 per cent on LTCG of Rs 10 lakh. Now in the wake of STT replacing tax on capital gains from securities, the tax bill would come down drastically — an STT of Rs 750 would have been paid at the point of purchase and Rs 1,500 would be paid at the point of sale.

The aggregate STT thus works out to Rs 2,250. Now juxtapose this against the tax liability on salary of Rs 10 lakh. Ignoring education cess, it works out to a staggering Rs 3,01,400. It is a pity that institutional investors including foreign institutional investors (FIIs) with deep pockets would benefit as much from the new indulgent regime as small investors would.

FIIs are avowedly in the business of buying and selling shares. Their income like those of day traders should be taxed as business income. That they drive up the volumes in the market is no reason for letting them off the income-tax hook.

Mr P. Chidambaram should rethink his hypothesis that STT is a perfect alternative to income-tax. It may be an effective alternative from the exchequer's point of view given the fact that evasion thereof is well-nigh impossible with stock exchanges being fastened with the arduous task of tax collection on this account and also given the fact that there are no shelters available on STT. But it puts unearned income on a pedestal.

(The author is a Delhi-based chartered accountant.)