The Hindu Business Line : Turning over a turnover tax

MR P. Chidambaram's name will go down in the annals of the country's financial history as a Finance Minister who did his utmost for widening the tax base and raising the potential for revenue. This year, he has proposed the fringe benefit tax and the cash transactions tax. It was Sir John Maynard Keynes who first thought of a securities transaction tax (STT). His rationale was that the STT would discourage speculative transactions. The idea was developed by James Tobin, Joseph Stiglitz and law firm Summers & Summers. It was argued that the financial sector of the economy absorbed too much of resources relative to the social benefit it produced.

STT was imposed to raise the efficiency of the financial market, by crowding out market participants who did not behave rationally or wasted resources on speculative activities. STT has a strong potential to raise revenue. It can also be used as an instrument to reduce stock market volatility, improve market efficiency and reallocate social wealth.

Since capital has become highly mobile, tax policies have to be reoriented, especially with reference to capital gains tax. To encourage inflow of foreign capital, many countries have either reduced or abolished capital gains tax. STT can be seen either as a substitute for capital gains tax or as an independent tax. Capital gains tax is levied on profits realised on investment and sale of assets and it can be seen as income. STT, on the other hand, is a turnover tax and it should find no place in the Income-Tax Act of any country. Both the levies have one common purpose, that is, discouraging short-term speculative activities.

Till last year, short-term capital gains was taxed at the same rate as personal income, that is, between 20 and 30 per cent depending on the respective income slab of the assessee. Last year, long-term capital gains tax was abolished for listed securities. Taxation of capital gains with reference to the foreign institutional investors (FIIs) has to reckon with India's Double Taxation Avoidance Agreements (DTAAs).

While FIIs entering through Mauritius, Spain, Cyprus and the UAE need not pay any short-term capital gains tax owing to the exemption under the respective DTAAs, those from other countries have to. There was, thus, discrimination based on the country of origin in the matter of taxing short-term capital gains in the hands of FIIs. Similarly, domestic companies were also discriminated against, as they do not have the benefit of DTAA of any particular country to fall back upon for claiming exemption.

Budget 2004 abolished long-term capital gains tax for securities listed on the stock exchange and reduced short-term capital gains tax to 10 per cent. It was perceived that capital gains tax can be evaded or avoided. The STT will more than make up for the loss of revenue. After much debate, an STT of 0.15 per cent was imposed last year on equity share trading that involved delivery, and this was to be shared equally between the buyer and seller. Also, a tax of 0.015 per cent was levied on day traders and jobbers. Transactions in the derivative segment were taxed at 0.01 per cent. All dealings in bonds and government securities were kept out of the purview of STT, thereby providing a boost for the debt market. While presenting the Budget for 2005, the Finance Minister proposed a nominal increase in the STT. A day trader will pay a 0.02 per cent STT instead of the earlier 0.015 per cent. This increase will apply to all categories.

The revenue potential is expected to be around Rs 1,000 crore. The collection will depend on the turnover in the stock exchange. It is perceived that any rise in the STT rate will affect the total turnover and the asset values in the stock market. A recent study has shown that while the levy is common across the globe (barring the US), 15 countries have either eliminated or reduced their STT over the last decade. The European Commission has recommended the abolition of STT, as it leads to a shrinkage in the volume of transactions.

(The author is a former Chief Commissioner of Income-tax.)

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