The Union Budget 2008-2009 (Budget) presented by the finance minister P Chidambaram proposes to make some radical changes to the tax treatment of securities transaction tax (STT) for the financial year 2008-2009.

The current law

Under the current provisions of the Indian Income-tax Act, 1961 (the Act):

? Investor. Long-term (holding period exceeding 12 months) and short-term (holding period up to 12 months) “capital gains” on listed equity shares and equity-oriented units of mutual funds, on which STT has been paid, are tax-free and taxable at a flat rate of 10% (before surcharge, education cess, and secondary and higher education cess) under sections 10(38) and 111A/115AD respectively of the Act.

? Trader. Profit/gains from purchase / sale / trading of / in listed equity shares and equity-oriented units of mutual funds, on which STT has been paid, is taxable at the regular rate of income-tax under section 28 of the Act as “Profits and gains of business or profession”. But, under section 88E of the Act, STT paid on taxable securities transactions, the income from which is taxable under the head “Profits and gains of business or profession” is eligible for setoff/reduction against the income-tax payable on income from such transactions subject to the conditions stated therein.

However, STT cannot be claimed as an expense in computing the income chargeable under “Capital gains” (investor) and “Profits and gains of business or profession” (trader) as per sections 48/115AD and 40(a)(ib) of the Act respectively.

The Budget proposals

The Budget proposals include:

? Investor. A hike in income-tax on short-term capital gains on the transfer of equity shares or units of an equity-oriented mutual fund subject to STT from 10% to 15% (before surcharge, education cess, and secondary and higher education cess) under section 111A/115AD of the Act. This proposal has been triggered to remove the anomaly of dividend distributed by a domestic company being subject to dividend distribution tax (DDT) of 15% (before surcharge, education cess, and secondary and higher education cess). This move will raise the tax burden for short-term investors and also, indirectly, discourage short-term investing and promote long-term investing, the gains from which are tax-free.

? Trader. Introduction of section 36(1)(xiv) in the Act, whereby STT paid on taxable securities transactions in the course of business, the income from which is taxable under the head “Profits and gains of business or profession”, will be allowed as an expense for computing such income and consequently, section 40(a)(ib) would be removed. Further, tax rebate under section 88E of the Act will be removed.

Let us consider a case study (see table) to understand the impact of the above changes.

We observe that the above amendment has substantially increased the tax burden for traders and will shrink the margins from STT trading arbitrage.

? General. Currently, in the case of sale of a derivative, where the transaction of such sale is entered into in a recognised stock exchange, the STT is at the rate of 0.017% and is payable by the seller. The Budget proposes to amend sections 98 and 99 of Chapter VII of the Finance (No 2) Act, 2004 to provide that with effect from June 1, 2008:

(i) In case of sale of an option in securities, STT shall be levied at the rate of 0.017% of the option premium and shall be paid by the seller

(ii) In case of sale of an option in securities, where option is exercised, STT shall be levied at the rate of 0.125% of the settlement price and shall be paid by the purchaser; and

(iii) In case of sale of a futures in securities, STT shall be levied at 0.017% and shall be payable by the seller.

Therefore, the amount of STT in the case of options payable by a purchaser and seller would now change as compared to earlier.

Conclusion

The above analysis shows that on the whole, the Budget will raise the tax incidence on short-term investors and all traders.

The author is a practicing chartered accountant