A mischievous tax on commodity trade

Before the Budget, the media was swamped by reports that the Finance Ministry would levy commodity transaction tax (CTT) on derivative trades in commodities. This was to be on the lines of the securities transaction tax (STT), to ensure what stock exchanges mischievously described as a ‘level playing field’. The commodity industry, however, unwittingly believed that such a tax would not be imposed.

The Finance Minister had announced CTT even as early as in 2008, but chose not to introduce it later, even though he then went along with securities transaction tax (STT). He perhaps realised that commodity exchanges were not stock exchanges, and that the objectives of the two markets have nothing in common. Commodity derivatives are hedging instruments, while securities serve as investment tools.

UNJUSTIFIED MOVE

Surprisingly, while reading out Budget 2013-14, the same Finance Minister declared that “there is no distinction between derivative trading in the securities market and derivative trading in the commodities market, only the underlying asset is different.”

While “taking note of the changes and shifts in the market”, he proposed in his Finance Bill for 2013 to reduce STT on equity futures from 0.017 per cent to 0.01 per cent, and that on sales of units of mutual funds (MFs) and exchange traded funds (ETFs) on stock exchanges from 0.1 per cent to 0.001 per cent. In the same breath, he proposed to levy CTT on non-agricultural commodities futures contracts at the same rate as on equity futures, i.e. at 0.01 per cent of the price of the trade. By way of a small sop, he then announced that “trading in commodity derivatives will not be considered a ‘speculative transaction’ and CTT shall be allowed as a deduction if the income from such transaction forms part of business income”.

What made the Finance Minister change his mind within a period of just four years is hard to fathom. If, except for the underlying assets, derivatives in commodities were in no way different from those in securities, why has the Finance Minister exempted currency and farm commodity futures from CTT? How can such discrimination be justified either in logic or in law?

DECEPTIVE SOP

The apparently sweet sop is deceptive as well. For, the Finance Bill 2013 cleverly inserts in sub-section (1) of Section 36 of the Income-tax Act, a clause, Clause (XVI), to allow deduction of “an amount equal to the commodities transaction tax paid by the assessee in respect of the taxable commodities transactions entered into in the course of his business during the previous year, if the income arising from such taxable commodities transactions were included in the income computed under the head ‘profits and gains of business or profession’.”

Nowhere does the Finance Bill provide that a commodity derivative trade will not be considered as a speculative transaction, nor does it permit profits and losses from commodity derivative trades to be offset against losses and profits from any other business income, as has been allowed for securities trades, under Section 45 (5) of the IT Act. Under Chapter 7 of the Finance Bill, a recognised commodity association is only regarded as “assessee”, and enjoins on it to collect CTT on trades carried out at its exchange. That means that it alone can claim the benefit of deduction of CTT. But since no association carries out on its own any commodity derivative trades, it obviously cannot claim any such deduction.

And even if it were permitted to claim deductions on behalf of its members, such deductions will be allowed only on profits and gains made by those members on their derivative trades in non-farm commodities, and not from any other business.

DUBIOUS ECONOMICS

In principle, it is far from fair to tax a transaction per se . For, a transaction, especially a derivative transaction, by itself does not lead to any value addition. It may result in loss as well. It is a cardinal principle of public finance and taxation that tax must be realised out of income, aside from taxation of acts such as smoking or drinking. The concept of transaction tax is neither rational nor fair, and against the well-recognised canons of taxation. It can undermine sustainable growth of the economy.

As for derivative transactions, if such transactions in a year were to result in gains, such gains would anyway be taxed as income.

Transaction tax in that event simply implies double taxation. Even if CTT were allowed to be deducted from the overall profits from derivative business, what about those who incur losses from such businesses?

To some economists, CTT is not a tax, but a penalty to be paid for undertaking a perfectly legitimate and economically useful business.

Neither STT nor CTT should have any place in taxation laws. It is a mischievous brainwave of left-wing politicians from the West, who have been demanding financial transaction tax (FTT) on securities markets, and refuse to recognise the economic rationale of derivative markets.

While the governments in the West, barring France, have rejected the demand, even France has excluded securities derivatives from the application of FTT. As for commodity derivatives, CTT does not exist anywhere in the world.

LIQUIDITY CREATORS

In reality, most day-traders such as jobbers, scalpers, swing traders, who account for the bulk of trading volumes in commodity derivatives, trade on slender margins. Together, day-trades are a zero-sum game. Yet, such trades perform the vital economic function of absorbing hedges of physical market functionaries, the moment they are required, without much variation in market price. This is because of their willingness to absorb price risks. In fairness, they actually create the much-needed liquidity in derivative markets, and keep the impact cost (bid-ask spread) quite low.

The proposed CTT, being as much as three times the prevailing transaction fee of commodity exchanges, will surely render their trades uneconomical, and force them to leave the market. As they abandon commodity exchanges, hedgers from the physical markets will inevitably follow suit because of the resulting high bid-ask spread.

With the departure of day traders and hedgers, and the inevitable demise of the market, as a result, merchandising and processing margins will rise swiftly through the commodity supply chains in the physical markets to fuel further the prevailing inflation. This will affect adversely the marketing of even agricultural commodities.

For, even if non-agricultural commodity futures transactions were taxed, the resulting inflation in them is sure to soak into the prices of farm commodities. Inflation spreads like a virus from commodity to commodity, and even to services.

Targeting of non-farm commodities was the agenda of vested interests to damage a world-renowned exchange in India, which has received accolades from international financial industry. The Finance Minister should not fall prey to such a design. He should withdraw his proposal to levy CTT in the larger interest of the economy.

COMMENT NOW