Monday, October 24

Demands of revoking STT rising day by day

While introducing the Securities Transaction Tax (STT) in 2004-05 on stock market trades, the then finance minister P Chidambaran seems to have been inspired by one of the basic rules of the stock broking business— whether the client gains or loses, the broker still gets his commission.
Similarly, irrespective of the day-trader/investor making money or not, the government would still get the STT owed to it. That was fine as long as the stock market was booming; stock traders made enough money and didn’t mind handing over a small share of it to the government. But in a downturn, the STT is hurting. Many day-traders (called 'jobbers' in market parlance) have quit the profession, unable to make a decent profit on their trades. In July this, Delhi-based BLB Securities, which employed around 1000 jobbers, asked all but 60 of them to leave, as the arbitrage business had become unviable.
Last week, Bombay Stock Exchange CEO Madhu Kannan told media that ‘STT was one of the reasons affecting volumes in the cash segment.’ The week before that, Sebi chairman UK Sinha spoke of the high cost of transaction in the Indian market, without explicitly mentioning the Securities Transaction Tax.
Media reports have quoted finance ministry officials saying the government will ‘rationalise’ the STT in the upcoming Budget. A cut in the STT or scrapping it altogether (as has been proposed in the Direct Taxes Code) is unlikely without the government revising the tax on capital gains (15% on short term, nil on long term).
It is easy to see why the government would prefer to retain STT rather than tweaking the capital gains tax structure. STT nets the government around Rs 7000-7500 crore annually, and it is next to impossible to evade this tax as stock exchanges have the record of every single trade. So the government does not have to spend much to ensure compliance. On the other hand, tax payers can— and often do— dodge capital gains tax by offsetting them against fictitious losses, which are not too hard to obtain. That makes it expensive for the government to ensure compliance.
The broker/trader community’s argument is that STT is hurting trading volumes as it makes day trading unviable for majority of the small players, who are a key source of liquidity.
On an intra-day cash market trade, the STT is 2.5 paise (each on the buy and sell side) per Rs 100, and 1.7 paise (only sell side) per Rs 100 of a derivative trade. That sounds a negligible cost. But if a jobber generates around Rs 50 lakh of turnover through repeated buying and selling through the day, his STT liability works out to Rs 1250 for cash market trades and Rs 850 for derivative trades. Jobbers work on a profit sharing basis with the brokers on whose terminals they punch the trades. The broker takes the advantage of the rebate on STT (it can be set off against income tax liability), but the jobber gets his share only after all the fixed charges (STT, stamp duty, exchange turnover fee) are deducted. Jobbers complain that STT eats into a sizeable chunk of their profit. Too many jobbers being put of trade does affect liquidity, which then triggers a vicious cycle of volatility and low trading volumes.
Yet, the problem being faced by jobbers is no longer about STT alone. Theoretically, even if STT were to be cut or scrapped altogether, it won’t make too much difference to trading volumes. Non-institutional broking firms, many of which used to employ a large army of jobbers, have scaled down operations considerably over the last couple of years. In addition to adverse market conditions, they are no longer in a position to compete with institutional players—especially foreign brokerages—which have access to low cost funds, and superior technology for algorithmic trading. As the name suggests, algorithmic (algo) trading or program trading is about trades being executed by software based on pre-specified condition. An algo software can execute complex trades in milliseconds, something humanly impossible. Algo trading is known to cause sudden price swings that result in heavy losses for the smaller players. Not that all algo trades are profitable, but the deep-pocket brokerages using the software have the staying power that smaller arbitrage firms lack.
While the government may make noises about rationalising the STT structure, it would be secretly hoping that the market recovers before the next Budget. If that happens, STT will be a forgotten topic, like it was during the bull market between 2004 to early 2008. But if the market remains comatose, the government will have no option but to slash STT, and review capital gains taxes. Already the government has begun cracking on the routes being used to evade short term capital gains tax. From August this year, stock exchanges started penalising brokers who transferred their trades from one client’s account to the other. This tactic was used by brokers to generate artificial losses/gains depending on their clients’ requirements.


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