Securities trading tax structure biased towards speculative derivative trade: BSE

New Delhi: To check tax evasion and attract more retail investors to stock markets, top exchange BSE has proposed that the Securities Transaction Tax (STT) should be substituted by Long Term Capital Gains Tax (LTCG) on equities.

This would also help the government get more tax revenues as the overall STT collection (about Rs 21,000 crore in last four years) is far below the quantum of suspected tax evasion.

"If STT is substituted by LTCG on equities, government would get more revenue, misuse of the tax incentive curbed and retail investors would come back to market," BSE has said in a a presentation to the Finance Ministry.

In last four years, BSE and NSE had collected STT to the tune of Rs 21,090 crore, while the suspected tax evasion by misuse of incentives available in stock market is estimated at about Rs 20,000 crore in just a one-year period.

The capital gains needs to paid on profits made by an investor. But, the LTCG in stock market is nil if the investment is held for more than a year.

The STT on the other hand is payable on all sale and purchase transactions of the securities. In the STT structure, apart from paying the tax twice, an investor has to shell out money irrespective of profit or loss on the trade.

However, this structure is often misused by those looking to evade taxes as they sell the shares through stock market by paying the small amount of STT and get the full benefit of exemption from the LTCG tax.

The STT was introduced in Finance Act, 2004. At that time, this marginal tax regime was brought in to boost capital raising through primary market issuances. The shift to STT was also aimed at providing an attractive investment proposition from tax perspective to increase investment in the secondary markets as compared to other non-equity investments.

However, the STT structure has resulted in "a bias towards greater speculative derivatives trading" over years, while liquidity in cash market has been declining, BSE said.

"Post-STT, there has been an exponential increase in the turnover in derivatives segment. Lower rate of tax for derivatives seems to be providing the incentive for excessive trading in derivatives markets," BSE said, while adding that India has the second largest ratio of turnover of equity derivatives to equity cash in the world (after Korea).

"Growth in derivatives trading has far outstripped equities markets growth... Liquidity in underlying market has declined consistently," the exchange said while adding that Indian markets are amongst most illiquid markets by the measure of trading volume to market capitalisation.

Many entities including companies and individuals have generated fictitious long-term capital gains by misusing the stock exchanges platform to evade tax. However, action has been taken against several entities by markets regulator Securities and Exchange Board of India (Sebi).

Further, Sebi had also issued orders relating to tax evasion using derivatives markets.