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Amendments that dont measure up
April, 05th 2008

The Securities Transaction Tax (STT) was introduced into the income-tax code by the Finance (No. 2) Act, 2004, taking effect from April 1, 2005. It was expected to give a major boost to both the income-tax department in terms of revenue and the equity market. When STT was paid on share transactions, no liability for long-term capital gains tax arose. Short-term capital gains were taxed at 10 per cent if STT was paid. This was the position till March 31, 2008.

Finance Bill, 2008 has revised the rate of short-term capital gains (STCG) tax from 10 to 15 per cent. The Income-Tax Act has been amended for this purpose. In Para 177 of the Budget speech, the Finance Minister give the rationale for the upward revision:

Dividends that are distributed attract a tax of 15 per cent. Short term capital gains attract a tax of 10 per cent under Section 111A. There is merit in equating the rates and hence I propose to increase the rate of tax on short term capital gains under Section 111A and Section 15AD to 15 per cent. This will also encourage investors to stay invested for a longer term.

Dividend Distribution Tax (DDT) was raised to 15 per cent last year from 12.5 per cent. That was resented even last year. At a time when there were expectations that the DDT may be removed from the statute book, the Government has thought it fit to raise the STCG tax to 15 per cent instead of reducing the DDT to 10 per cent.

An anomaly

Section 111A taxes short-term capital gains tax at 15 per cent. The revised tax slabs have come into operation from April 1, 2008. Taxable income between Rs 1,50,000 and Rs 2,50,000 will be taxed at 10 per cent. Supposing an individual has got Rs 2,00,000 as STCG and no other income, under the new dispensation, will he be taxed at 15 per cent even though the general rate for his income level should be only 10 per cent? Will this represent a clear understanding of the legal position? Is it possible to argue that the Finance Act provision of 10 per cent should apply in this case?

There can be no doubt that investors may have to think twice before exiting the stock market within 12 months. The higher STCG rate will be a deterrent. The hike in the STCG rate could be one of the reasons for the low volumes and decline in the stock market. Foreign Institutional Investors which do not have the cover of the Double Taxation Avoidance Agreements (DTAAs) stand to suffer.

A notable change has been made by the Finance Bill with regard to the Securities Transaction Tax. Hitherto, this has been allowed as a rebate under Section 88E of the Act. The Finance Bill abolishes this rebate. Instead, the STT will be allowed as a deduction in the computation of business income.

Rebate discontinued

Discontinuance of the rebate under Section 88E is followed by the insertion of a new provision in Section 36 of the Act. It is laid down that the STT paid during the year shall be allowed as a deduction under Section 36 on the condition that the income from taxable securities transaction is included under the head, profits and gains of business or profession. A rebate is a deduction from tax. The deduction under Section 36 will be from income. The change is adverse to the taxpayer.

There has been a long-standing controversy on the question of the treatment to be given to income from transactions in the stock market. Will it be capital gains liable for tax at special concessional rate or will it be treated as business income? Circulars issued by the department from time to time have only added to the confusion. Under our scheduler scheme of taxation, it makes a big difference whether the income is computed under business or other sources. The Finance Bill does not provide any answer. Instead, it complicates matters further by laying down that the STT will be allowed as a deduction in the computation of income from business or profession.

Section 40(a)(ib) of the Act prohibited deduction of any amount paid on account of STT hitherto. Clause 8 of the Finance Bill seeks to omit Section 40(a)(ib) w.e.f. the assessment year 2009-10. The entire amendment with regard to STT is seen by several critics as regressive from the market point of view. Where as formerly 100 per cent tax rebate was allowed, hereafter there will only be a conditional deduction of STT. It is not explained what prompted this change.

Within four years, there have been quick changes in Section 111A and the way capital gain from the share market is treated. This does not enhance stability in the tax system. There is no certainty that even the present tax regime with regard to STCG and STT will continue.

T. C. A.Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)
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