What’s needed for growth of capital markets in 2019

January 03, 2019 12:11 PM

In 2018, a multitude of regulatory changes was proposed by the market regulator Securities and Exchange Board of India (SEBI) that will reshape our markets in the coming year.

The Union Budget 2019-2020 needs to address some of the concerns of the industry.

By Rajesh Baheti

In 2018, a multitude of regulatory changes was proposed by the market regulator Securities and Exchange Board of India (SEBI) that will reshape our markets in the coming year. Among the important regulatory decisions taken include Interoperability of Clearing Corporations, Unified Cash/F&O Settlements, Delivery based F&O and Cyber security.

While the regulatory environment has been shaping up well for the Indian Capital Markets, policy support from the government will be crucial to sustain the current pace of its growth and development.

Policy boost with regulatory support

Quantum and ease of collection alone cannot determine levy of a tax. Any tax primarily needs justification for its levy. In the recent past, the capital markets have been levied with a multitude of taxes. Much has to do with the fact that it’s a transparent business that offers a complete audit trail, thereby making it easy for the government to collect such taxes. These levies, when looked at from the combined effect they produce are bottlenecking the growth of capital markets.

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The Government needs to create an enabling environment for the Capital Markets to flourish that will help India’s transition from a nation of savers or investors in gold, fixed return instruments or real estate into a nation of long-term equity investors providing much-needed risk capital for the economy’s growth. At the same time, it also needs to recognise that markets need to be liquid, that markets cannot remain liquid with the participation of long term investors alone, and therefore market makers and traders play an equally important function, and participation by such players needs to be encouraged, rather than disparaged by calling them “speculators”.

Tax reforms need of the hour

The Union Budget 2019-2020 needs to address some of the concerns of the industry, which mostly requires creating a reasonable tax regime that encourages all stakeholders to participate in the markets – from investors to financial institutions, and market makers to traders.

In order to remove double tax of capital market transactions, firstly, the government needs to reintroduce the rebate under Section 88E under Income Tax to give market makers and traders a fair and equitable tax regime. This will give a fillip to market volumes.  Under Section 88E, the STT paid on exchange transactions accounted for as business income was available as a tax rebate with no refund or carry forward provision. Subsequently, this rebate was withdrawn, leading to professional traders in the market being taxed twice, once at STT stage, and then on their incomes at the maximum marginal rate.

As capital formation in India is still challenging, there is also a need to continue incentivise long-term investors. The government therefore needs to relook at the 10% tax, though it may define a longer holding period as being long term.

The tax on options exercise @0.125% on strike+premium value has led to option pricing distortion in the capital markets, as a result of which in the money options end up trading below their intrinsic value, that should never be the case going by financial theory. Besides, with physical settlement being introduced, the delivery STT of 0.10% is anyways levied on both the buyer and seller. The tax on options exercise is an anomaly that needs to be immediately revoked.

In most countries, corporate taxes are lower than personal taxes, and Dividends that flow from corporates to individuals suffer a tax mostly equal to the difference. India has wrongly levied Dividend Distribution Tax (DDT) while corporate rates of tax remain high. The current tax regime results in triple taxation of corporate earnings that are distributed and has led companies to favour debt capital over equity capital as the tax advantage clearly lies with debt versus equity.

At the time when the economy is reeling under the impact of the NPA mess, the government should consider urgent course correction by withdrawing the Dividend Distribution Tax on corporates and levying the tax on the recipient. As the government has promised to bring rates of corporate tax down to 25%, and as personal rates are at 35%, a 10% rate of tax on dividends, to be levied in the hands of the receiver would be the right and justified dividend tax levy. Such a tax, for ease of collection may be deducted by the corporate as TDS.

In order to encourage savings, channelize it towards productive assets and give a fillip to the divestment targets of the Government, an additional Rs 50 lakhs limit should be allowed under Section 54EC for investment in CPSE ETFs. Stamp Duty on Stock Exchange Transactions should be abolished as such transactions are already taxed by the levy of STT.

All these reforms, in addition to the regulatory backing and the efforts from the broking industry to ensure enhanced supervision, fair conduct, ethical practices and investor protection would together provide an immediate impetus for growth of our capital markets.

Rajesh Baheti is President of ANMI. The views expressed are author’s own.

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