With a couple of days to go for the Union Financial Budget of 2016-17, we take a closer look at the Union Financial Budgets of the previous year to see how the numbers add up.

As part of this feature, we take a look at STT or Securities Transaction Tax. How big is it?

What is STT or Securities Transaction Tax?

STT was originally introduced in 2004 by the then Finance Minister, P. Chidambaram to stop tax avoidance of capital gains tax. As per the Finance Act 2004, and modified by Finance Act 2008 (18 of 2008) STT on the transactions executed on the Exchange shall be as under:

  • Purchase of an equity share in a company or a unit of an equity oriented fund – Payable by  Purchaser
  • Sale of an equity share in a company or a unit of an equity oriented fund (Delivery / Settled ) – Payable by Seller
  • Sale of a derivative – Payable by Seller
  • Sale of a unit of an equity oriented fund to the Mutual Fund – Payable by Seller

Ah! Interesting. Wait – if the STT is just 0.1% in case of Delivery based trading or 0.01% incase of Futures trading – why should we care?

Lets’s see. STT is to be paid by you and me if we trade in Securities (Equities and Derivatives). Mutual Fund houses and Foreign Portfolio Investors also trades in securities and also pay out STT. So who is left out? None. 

Remember that we pay a lot other taxes as well. We pay service tax on brokerage while buying and selling. Later then we pay a capital gain tax (short or long) depending on the period of holding the investment. And then STT. So as a matter of fact, if a person earns his basic income from a job and invests in securities, he is effectively paying 3 different types of taxes. (Income Tax, Capital Gains Tax and Securities Transaction Tax)

The tax was implemented to basically bring in a wider audience under the tax section i.e. Mutual Funds (who don’t pay capital gains taxes or income taxes) and Foreign Portfolio Investors (who aren’t taxed in India on cap gains). These investors have been entering on the pretext that there will not be any taxes applicable to their income and the government circumvented this law with the introduction of STT. Effectively everyone has to pay STT. 

This is like the government telling that you buy a new car and don’t pay us any taxes for the purchase, but then we will go ahead and tax you ten different ways with cess, road tax, mandatory insurance etc.

STT Means No Long Term Cap Gains Tax

Paying STT means you have no long term cap gains taxes – so any stock held for over a year where the sale involves STT will see zero long term capital gains taxes. 

We’ve argued that this is likely to change as long term capital gains tax is reintroduced or made applicable only after three years. But as we’ll show you later, STT isn’t going to be removed easily. 

So how is STT faring?

In one word – BAAAAAD – a thumbs down.

The government’s income from STT has been an avg. of Rs. 6k Cr. (from 2009-10 to 2015-16). Though the STT was implemented in 2004, the government has not been disclosing the breakup of the Personal Income Taxes and hence the data has been made available only from 2009-10.

STT_1

This is what we derive from the data:

  • Personal Income Tax collection has doubled at 110.56% from 132.31k Cr.in 2009-10 to 278k Cr.in 2014-15, but STT collection has fallen from 7.39k Cr.to 5.9k Cr.- a fall of -18.96%. (In the same time)
  • Avg. growth of STT collection has been -1.17% compared to Personal Income tax growth of 16.3%.
  • STT has been falling, and it’s not been a huge money spinner for the government at least as a percentage of tax collected

Why Not Remove STT completely?

 For STT, the cost of collection is low: you just get the money from the exchanges! (And mutual funds)  Since it’s so easy to collect, it would make no sense for the government to give it up – they gave up wealth tax because it needed assessment and a higher cost, to collect what ended up being just Rs. 1,000 cr. Other taxes too, like Fringe Benefit Tax, were given up because they were such a pain to maintain. STT isn’t in that league – and like Dividend Distribution Tax (DDT) it’s unlikely to be removed.

Will it be increased? We don’t know – but it will spook traders if it’s removed.

Removing STT will also reintroduce capital gains tax. So can we make up for the lost revenue if we scrapped STT, by reintroducing Long Term Capital Gains? However, to make up for Rs. 6500 cr. you would have to see reported gains of Rs. 65,000 cr. (Since tax on securities, long term, is 10%). That is very very tough, because:

  • Retail is about 40% of all trading turnover; so at about 25,000 cr. per day for the whole exchange non institutions are about 10,000 cr. per day. (Institutions don’t pay tax)
  • A fairly large percentage of this is either short-term gains or intraday turnover. These two areas don’t qualify for long term gains, so they can’t replace STT. (They’ll be taxed in different heads)
  • Even if you assume that 10% of that is long term, that’s about 1,000 cr. per day. 
  • Of this, assume average profit of – let’s be generous – 15% on average. (since 1,000 cr. turnover doesn’t mean all of it is profit)  That’s Rs. 150 cr. per day of gains.
  • 150 cr. per day, for 200 days, is an annual profit of 30,000 cr. 
  • Tax on 30,000 cr. is only 3,000 cr
  • Which is much lesser than the 6500 cr. collected in STT

So this is a good reason why STT may not be removed, even though it is less and less significant in the larger scheme of things.

Plus, remember it’s the government’s way to tax people who are otherwise not taxed (mutual funds, Foreign institutions, pension funds). 

Our view: STT is easy to collect, and just 2% of overall personal taxes. It’s 0.7% of total tax revenues (including personal, corporate and indirect taxes). The actual collections – at Rs. 6500 cr. – are insignificant in the overall scheme of things. To give you an idea, the total STT in a full year, is less than the taxes on petrol and diesel in one month. But still, because of the lack of an alternative source of revenue, and the ease of collection, STT is unlikely to go. However, we might see a rejig in the tax numbers, or by a change in where it is applied (and perhaps it might be made applicable to private company exits as well, which is a big saving for startups). 

 

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Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion. 

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