|Wednesday, 28 September 2011 00:00|
It is plainly absurd to think that a reduction of the securities transaction tax (STT), as the finance ministry is reported to be planning, can revive sentiments in the Indian stock market. The markets are tanking as funds withdraw aggressively from each
global market into currency and gold. Some amount of the domestic sell-off is also partly due to policy stasis in the Indian government. Any cut in STT will lead to at best a half-day rally, which will be utilised by those with illiquid positions to promptly sell off their holdings. The market will return to the same depths it is now in and the government will be poorer by up to R7,500 crore annually that it earns from the levy. If these are the fiscal measures that North Block has in mind, then these are best avoided.
At a deeper level, there is no doubt STT is a flawed tax that needs to be taken off the law books, but surely not this way. The reason why STT is flawed is that direct taxes work best without distortion when they are made residence-based. In other words, they must apply on
all residents of a country based on their income and on consumption level, but irrespective of nationality. STT is levied on neither, but on turnover. The more frequently one transacts in a capital market, or the more technology improves to quicken turnover, the more tax government earns. It is like taxing the turnover of goods that we have eliminated through VAT. Instead, STT makes the Indian markets costlier compared with places where it does not apply. So, there is a very good reason to eliminate the tax and not just reduce it, even though it has made it possible for the government to withdraw the long-term capital gains tax on the securities market. The withdrawal, in turn, will sharpen the tax advantage companies registered in Mauritius enjoy vis-à-vis India-registered companies—the latter will have to pay long-term capital gains taxes while the former will not.
But all this is wrong thinking. The problems in taxing of the financial sector can be solved if the government allows the new Direct Taxes Code to be grounded entirely on residence-based taxation. In that case, all investors in the Indian market will be taxed on the income they earn from here, irrespective of whether they are foreign or domestic entities. This will make the Mauritius route obsolete without having to rework the double-taxation agreement or reviving the debate on capital gains. This is also in line with the international tax principles, like the ones enunciated by the OECD. The changes in capital market fiscal policies, therefore, need to be thought through with all threads in place instead of such piecemeal suggestions.