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Short selling: Clarity needed on tax issues
February, 27th 2008

A few weeks back, SEBI and the RBI decided to permit all classes of investors, including institutional investors, to short sell and put in place simultaneously a full-fledged securities lending and borrowing scheme for all market participants in the Indian securities market under the overall framework of Securities Lending Scheme, 1997.


Short selling involves sale of a security that the seller does not own. According to the scheme, investors are required to mandatorily honour their obligation of delivering the securities at the time of settlement. Borrowing of equity shares shall only be for the purpose of delivery into short sale. The tenure of lending/borrowing shall be fixed as standardised contracts.

To start with, contracts with tenure of 7 trading days are proposed to be introduced. There shall be no lending/borrowing activity during the periods of corporate action in the security. The margin/collateral shall be maintained only in cash. No interest shall be paid on such collateral.

Short selling/lending of securities is likely to be implemented shortly. However, there are host of tax aspects which need to be addressed and ironed out by the tax authorities.

Clarity needed

To begin with, the application of FIFO method to determine the period of holding and the cost of acquisition of securities lent and returned in the demat form requires clarification from the tax authorities.

Further, complexities also arise on characterisation of the fees receivable by the lender of securities viz., whether fees could be characterised as income in respect of securities (especially in case of a foreign institutional investor) or income from other sources or business income.

Similarly, there is no clarity regarding the method of application of the criteria or principles on characterisation of income viz., business income or capital gains, on short sale of securities in the hands of the borrower. Also, there is a doubt whether the shares short sold can be regarded as held on the date of transfer for the purpose of classifying it as capital asset. Similarly, whether borrowing charges could be regarded as an expenditure incurred wholly and exclusively in connection with the transfer of a capital asset for the purposes of computing capital gains or not, requires clarity from the tax authorities.

Further, when the borrower (beneficial owner of securities lent) returns the corporate benefits viz., dividend accrued on the borrowed securities to the Approved Intermediary to be finally returned to the lender, the issue that arises is whether such dividend would still be exempt in the hands of the lender, since he has not received such dividend directly from the concerned Indian company (after payment of dividend distribution tax). If regarded as exempt in the hands of lender and borrower/ buyer, a sum larger than that declared and distributed by the company is exempted from tax. A clarification is desired on these issues.

STT Burden

The existing tax provisions also lack clarity on whether securities transaction tax would be applicable on transactions of short selling of securities.

The market is hoping that the forthcoming Budget and the Central Board of Direct Taxes would soon provide clarity on these issues. The Finance Ministry could also take clues from the debt markets where lending and borrowing in G-Sec in the form of Repo transactions has been in place and functioning without any glitch for a couple of years.

Sunil Gidwani
Vijayashree R.
Kinnari Mehta
(The authors are with PricewaterhouseCoopers)

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