NSE to levy 10 times higher STT on physically-settled derivatives

Since the contracts lead to actual delivery of shares, investor to be charged 0.1% STT instead of 0.01% under cash-settlement

Investors in derivatives, reeling from regulatory tightening, have received a fresh jolt.

The National Stock Exchange (NSE) has decided to levy the securities transaction tax (STT) at 0.1 per cent on derivative contracts of stocks that are physically settled. This is 10 times higher than the 0.01 per cent STT levied on stocks that are cash-settled.

To crack down on excessive speculation in the derivatives market, the Securities and Exchange Board of India (Sebi) made “physical settlement” mandatory for stocks that failed to meet certain criteria. 

In April, the NSE issued a list of 46 stocks whose derivatives contracts result in physical delivery of shares. The ongoing July series derivatives contracts is the first month in which contracts in these 46 stocks will be physically settled. 

Under this, if one does not square off the open position until the expiry, the investor will be forced to either sell shares or take delivery of shares, depending on the type of position.

Illustration by Binay Sinha

Brokers say the higher STT could lead to tax discrimination within markets. For instance, an investor who sells futures contracts of Reliance Industries would be subject to 0.01 per cent STT while an investor who sells contracts of Reliance Communications will have to pay 0.1 per cent since the derivative contracts of the latter have to be settled physically. “Investors are being forced to take physical delivery of certain stocks due to the regulatory mandate. Hence, they should not be subject to any additional tax. The tax department should come out with a detailed note explaining how such transactions would be taxed,” said a source.

However, providing a relief to physically-settled trades could give tax arbitrage opportunities. If the STT on physically-settled contracts is lowered, investors could prefer taking this route for buying shares as against the cash segment, where the STT is 0.1 per cent.

“There is currently some ambiguity over STT applicability on the 46 stocks that are headed for physical delivery. Investors should avoid any speculative transactions in these stocks. In case if they have taken positions in these stocks for hedging purposes, they should exit before the expiry to avoid extra tax outgo,” said Chandan Taparia, derivative analyst, Motilal Oswal Securities.

Experts say if all traders are to square off their contracts to avoid higher tax, it could lead to imbalances in the market.

Meanwhile, the Association of National Exchanges Members of India (AMNI), the brokers’ lobby, has shot off a letter to the NSE on the issue following a circular from the exchange.  

“As there is no legal provision for levy of the STT on the futures and options segment delivery transactions, any attempt to collect the same by the exchange upfront shall also become an illegal act,” the AMNI stated.

Traditionally, derivatives have enjoyed favourable tax treatment compared to cash markets. For instance, intra-day transactions in the cash market, wherein investor does not take delivery of stocks, are subject to 0.025 per cent STT while the tax slab goes up to 0.1 per cent if the investor takes delivery. On the other hand, the STT on sales of future contracts is only 0.01 per cent.  Sales of options attract a relatively high STT rate at 0.05 per cent. However, the STT in the case of options is calculated on the basis of premium turnover rather than the actual turnover. 

Earlier this year, Sebi is said to have written to the government on disparity in taxation between the cash and derivatives markets. The Centre is said to be examining the issue.