Taxes set to axe volumes

BUDGET 2008-09: IMPACT

New Budget levies will hit big brokerage houses the most.

The trading volume in the Indian securities market, which has already come down by half after the market crash of January-end, may continue to decline following the Union Budget's proposal to hike the short-term capital gains tax by 50 per cent and the change in the computation method of the securities transaction tax (STT) from April 1, 2008.

Big brokerage houses, which have big proprietary trading books, will be the most affected according to the new rules for computing STT and they will be forced to pay more tax on their income, say experts.

The Union Budget has proposed to discontinue the rebate (under section 88E of the Income Tax Act) for the STT paid (and to consider it as business expense instead). This could result in higher effective tax outgo for traders, impacting volumes of day traders and arbitrageurs, according to HDFC Securities in a note to its clients.

"STT is a negative for assessees claiming it as business income. This is because, henceforth, STT would be allowed as expenditure against your business income (and would not be adjusted against your tax liability) and thus, the effective tax burden would stand increased," said Angel Broking in a note.

"The steps should have been ideal in a raging bull market. But now we are nearly in a bear phase and this will impact the market sentiment further," said Alex Mathews of Geojit Financial Services.

"Unless there is panic selling following the extremely weak global cues, we should see trading volumes getting affected further due to the hike in the short-term capital gains tax," he said.

The Sensex, which fell over 20 per cent from the peak during the January-end crash, is still over 15 per cent down from the peak of 20,873 posted on January 8.

"Arbitrageurs and traders will be the most hit. They are the ones who create liquidity in the market," adds Amitabh Chakraborty of Religare Securities.

Traders (who enter and exit stocks by undertaking intra-day activity) are in the market for a margin of 3-4 per cent. Following the hike in short-term taxes, they may have to pay another 1.5 to 2 per cent extra as tax, resulting in a further squeeze in their margins, said Chakraborty.

At the market peak of January 8, volumes in the cash market topped Rs 37,301 crore (Rs 11,867 crore on BSE and Rs 25,434 crore on NSE) and another over Rs 85,000 crore on the National Stock Exchange's derivatives segment.

Following the crash of January 21 and 22, cash market volumes on BSE and NSE combined is now Rs 22,537 crore, down by about 40 per cent. On NSE's derivatives segment, volumes have come down by a half at around Rs 42,000 crore.

Trading volumes, however, can go up if there is another crash in the market. This is because during the crash of January 21 and 22, (the Sensex fell by 2,284 points to 16,729 in two days), the turnover was higher at Rs 33,859 crore (BSE at Rs 9,334.40 crore and NSE at Rs 24,245 crore) mainly due to sell-off of clients' positions by brokerage houses to meet mark-to-market requirements.

A levy of tax on services of stock exchanges and clearing corporations could also result in an increase in transaction costs for traders and investors, said the note by HDFC Securities.

On the hike in short-term capital gains tax from 10 per cent to 15 per cent, another brokerage house note said.

"Day traders, who thrive on short-term volatility, anyway treat income from such transactions as business income. This particular provision would impact those classes of investors who take an extremely short-term view of the market and are unable to hold onto their investments for more than one year."