Commodities Transaction Tax can wait

Frederick the Great, the 18th century Prussian king said: “No government can exist without taxation. This money must necessarily be levied on the people; and the grand art consists of levying so as not to oppress.”

The Finance Ministry must be contemplating whether reviving the Commodities Transaction Tax (CTT), mooted some years ago, albeit in a different form would be termed oppression.

The numbers are too tempting to ignore — December saw a total transaction value of Rs 1,77,595 crores on the National Commodities and Derivatives Exchange. Word is around that the Ministry is attempting to kill many birds with one stone — extending the scope of the Securities Transaction Tax (STT) to commodities and reducing the rate of STT. STT is expected to bring in Rs 7,500 crore this financial year and it will not be wishful thinking to expect a similar target from CTT over time. The reduction in the STT will provide a good dose of oxygen to markets while the extension of the tax to commodities will offset any decrease in tax revenues due to the reduction.

CTT Provisions

As a concept, CTT is not new. The Finance Act 2008-09 proposed a levy of CTT at 0.017 per cent for sale of an option in goods or an option in commodity derivative and sale of any other commodity derivative and 0.125 per cent for sale of an option in goods or an option in commodity derivative, where option is exercised.

The value of the taxable commodities transaction would be the option premium, the settlement price of the option in goods or option in commodity derivative, as the case may be or the price at which the commodity derivative is sold. Waves of protest succeeded in the levy being temporarily shelved. While the tax was levied on the seller, if the option was exercised, the tax would fall on the purchaser.

Need for CTT?

There are many reasons why the Ministry should think twice about reintroducing CTT. The overall market mood is as mediocre today — if not more — as it was in 2008-09. Even when STT was introduced, it was not welcomed with open arms by stock traders though the stock exchanges had been there and done that in terms of experience. An imposition of CTT at this point is bound to take some sheen away from the commodities market.

The fact that it is proposed to be levied on non-agricultural derivatives will not assuage the fears since 80 per cent of trading in derivatives happens in non-agricultural commodities. Traders in commodities are as tax-sensitive as their brethren on the bourses and hence any increase in costs through taxes could force them to divert their trading strategies to an alternate market where they are not accountable.

At a time when commodities such as gur are making amends for the overall decline in the stock markets, it would seem unnecessary. Commodity trading is invariably large-volume, low-margin business. Back-of-the envelope calculations show that a 0.017 per cent levy would affect costs to the extent of 800 per cent. As the number of transactions increases, the futures market will turn more efficient in performing its principal function of providing the benefits of price discovery to various types of producers, especially farmers. More transactions would mean better management of price risks.

A large number of arbitrage transactions would help in linking the futures and options prices to real prices. CTT-induced lower trading volume, on the other hand, could lead to higher volatility in prices, impairing the market's price-discovery function. Unlike in the stock market, investment institutions, mutual funds and foreign institutional investors are not permitted to operate in the commodity futures market. Besides, options contracts, index futures and futures based on intangibles are also prohibited in the commodity futures market.

This would make it difficult for distortionary elements to attempt rearranging market mechanisms. Despite these checks and balances, the NCDEX has had to debar a few firms from dealing in commodities due to malpractices in guarseed.

The top 25 commodity derivative exchanges in the world are not subject to any form of transaction tax. Also, there is no transaction tax in the currency derivative market and on gold exchange-traded funds.

What's needed at this moment is to allow futures markets to play a more meaningful role in helping India's farmers to realise higher prices for their produce. Market participants, especially farmers and co-operatives, need to be encouraged to make additional investments in marketing infrastructure such as price dissemination networks, warehousing, storage facilities and testing laboratories.

Robust commodity exchanges and a strong futures market are essential for creating the conditions conducive to such investments. A tax on transactions can wait till all such investments have been made.

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

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