Time not right for transaction tax on commodity futures, say experts

Participants at a round table discussion on the impact of taxing commodity futures transactions (CTT) were unanimous about the untimeliness and the overall deleterious impact of the proposed levy.

Most participants at the round table, hosted by CNBC-TV 18 with Business Line as the print partner, sought to stress the primary difference between commodity futures and equity (cash and futures & options) markets.

Trading in the latter is purely an investment activity, whereas the ultimate purpose of commodity futures, just as interest rate and currency derivatives, is to facilitate hedging by those exposed to risks arising from their ‘core’ businesses.

The above risks could emanate from adverse movement of prices of the commodities handled by them, whether as primary producers, processers, traders, exporters or importers. These businesses need to similarly hedge against any untoward fluctuations in interest rates or exchanges.

Markets transaction tax

Madhoo Pavaskar, Director (Research & Strategy) at Financial Technologies India Ltd, felt that taxing markets transactions was a bad idea in general. The Government should tax only income or when people make money out of transactions, but not the transactions themselves.

The above principle, according to him, applies even to trading in equities and equity derivatives. In the case of commodity futures, it applies all the more because these are primarily ‘hedging’ and not ‘investment’ markets, Pavaskar said quoting Holbrook Working, a Professor of Economics and Statistics at Stanford University, known for his original contributions to the theory of futures trading and hedging.

Pavaskar noted that a CTT will basically drive away the day-traders, jobbers and scalpers, who account for 80 per cent of the trading volumes in futures markets, and take speculative counter-party positions that make hedging possible in the first place.

These people trade on very thin margins. And since they buy and sell, for any contract on the same day (so that the position is closed before trading ends), they end up paying tax on it twice.

“A good tax is one, where there is the ability to pay. Here, you are being asked to pay whether you make profit or loss. Hence, it is a bad tax,” Pavaskar added.

Anil Mishra, Chief Executive Officer of National Multi-Commodity Exchange of India, said a CTT will also affect hedgers because most hedging transactions do not result in any delivery.

(A farmer who sells a rubber futures contract to protect himself against a fall in prices will rarely make delivery against it; instead, he will simply buy-back or offset the contract before the delivery date, while selling the physical rubber in the local spot market itself).

If a CTT is imposed, not only day-traders but even hedgers would have to pay it twice on contracts that are liquidated by offsetting rather than resulting in actual delivery. While commodity exchanges have provisions for making delivery, these are meant more as a threat to ensure prices of futures contracts are in reasonable alignment with that in the underlying cash market.

“The basic purpose of a futures market is to enable both price discovery as well as price risk management. Any additional transaction costs will only distort both these functions, as one would have to first think about recovering these expenses before trading or hedging. The hedger would, then, rather prefer carrying the risk himself,” Mishra pointed out.

It is the awareness of the sensitivity of the market to the slightest of transaction costs that had led commodity futures exchanges in the country to deliberately reduce their own trading fees, from Rs 12 to Re 1 per lakh worth of transactions.

“What made us do this, but for the realisation that this market has limited tolerance for transaction costs. A CTT will widen the bid-ask spread and reduce liquidity in the market, and ultimately make it disappear,” he averred.

Naveen Mathur, Associate Director (Commodities & Currencies) at Angel Commodities, said the futility of transaction tax has been demonstrated even vis-à-vis the stock markets.

According to the latest revenue data, the Government has managed to collect hardly Rs 3,300 crore from the Securities Transaction Tax (STT) in April-January, compared to a level of Rs 8,000 crore at one point of time. A major reason for it is the volumes within the equity market shifting from the cash and futures segment to options, where the STT has to be paid only on the premium rather than the value of the actual traded price.

Moreover, the buyer of an option does not have even to pay STT if it is not exercised.

Making a related point, Mayank Khemka, a Delhi-based bullion wholesaler, noted that the imposition of STT of Rs 17 on Rs 1 lakh had already led to foreign institutional investors (FII) trading Nifty futures more on the Singapore stock exchange rather than the NSE.

“It will be worse for the CTT, where Taiwan is the only country in the world that levies it. India is today the largest gold consumer, but we are not a price setter. While having our own commodity exchanges can make some difference, the imposition of CTT will simply shift the trade to China and allow it to become the price setter,” he warned.

Anjani Sinha, Managing Director of the National Spot Exchange, rubbished the claim that levying a CTT will facilitate better tracking and monitoring of transactions on the country’s commodity exchanges.

“There is no basis for this because members/intermediaries are required to allot unique client codes for each customer and linking these to their PAN numbers before putting any trades. Besides, they are required to report all cash transactions above Rs 10 lakh to the Income Tax department,” he explained.

The idea of tracking trades by charging a tax may have made sense when the tax authorities did not have a proper IT infrastructure, which is far from the case today, he added.

“It would be the other way round. The CTT will make commodities trading go underground and result in money-laundering. You will only have unregulated dabba trading, where there will be no KYC (know your client) norms, margin requirements or threat of delivery,” said Ashok Mittal, CEO of Emkay Commotrade Ltd.

Commodities, equities markets

The participants in the discussion also highlighted basic differences between the country’s commodities and equities markets. There is currently no trading in options or indices in the former and nor are banks, FIIs, insurance firms, mutual funds and other institutional investors permitted in the market.

Further, while there is no long-term capital gains tax and a concessional 15 per cent tax on gains from sale of equities, any income from commodity derivatives trading (even if for hedging purposes) is treated as speculative gain or loss.

This cannot be set off against losses or gains from other businesses, as is now permitted for stock market transactions.

Crisis of credibility

According to Harish Damodaran, Deputy Editor, Business Line , the commodity futures market in India currently suffers from a ‘crisis of credibility,’ since there is very little participation from farmers, processors, traders and others with genuine underlying interest in the commodities being traded.

“Today, even banks lending to sugar mills are prohibited from selling futures contracts that could hedge against any price declines, which reduce the value of the collateral stocks on their advances. Similarly, options trading, which is something better suited for farmers and easier to comprehend than futures, is not allowed,” he observed.

The Government, instead of toying with the idea of a CTT, should focus more on making commodity futures markets relevant to those having real ‘physical’ exposure, as opposed to pure speculators.

The roundtable discussion was moderated by A.B. Ravi, Editor – Special Projects at CNBC-TV 18.

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