Sensible rollback

Now that Damocles' sword of turnover tax has been blunted, there is visible relief in the stockmarkets. The Sensex lost no time in crossing the 5,000 mark, which is significant because it had last reached that level during the finance minister's Budget speech, before he made the announcement about the turnover tax.

Miffed day-traders and arbitrageurs argued that the imposition of a high transactions tax would affect them unfairly because the income they earned from trading was really business income.

This, in effect, meant that they were unable to profit much from the finance minister's lowering of the short-term capital gains tax. The changes announced by the finance minister in his reply to the Budget debate correct this anomaly.

Traders can now treat the transactions tax as a cost that can be offset against business income. The lowering of the rate for traders (to 1.5 basis points, versus 15 for delivery trades) will also reduce fears of a drying up of volumes and higher impact costs.

More importantly, the finance minister has wisely refrained from revising the capital gains tax upwards to make up for the shortfall in collections from the transaction tax.

The cut in the short-term capital gains tax to 10 per cent and the scrapping of the long-term capital gains tax are very positive for the market, as amply illustrated by the recent rise in mid-cap scrips. What the reduction in short-term capital gains means is that the return from every profitable market transaction has gone up by 20 per cent.

This is a big plus for investors and substantially improves the risk-reward profile of stocks""a good thing to do when returns from fixed-investment avenues are dwindling. In the derivatives segment, where too the finance minister announced a sharp cutback in the tax to one basis point, the more significant issue relates to the treatment of capital gains by the taxman. The tax department has not clarified whether transactions in this segment fall under the head "speculative transactions", and need to be added to business income or not.

In the absence of such clarifications, and considering that many derivatives trades are in the nature of hedging transactions, tax professionals often advise their clients to book profits under the head of "capital gains".

The lower capital gains tax will, therefore, benefit this segment as well, at least so long as the tax authorities don't make an adverse ruling in this matter. Similarly, extending the benefits of the lower capital gains tax to equity mutual funds is an attempt to level the playing field for them.

For the debt markets, the finance minister's rollbacks mean a restoration of status quo ante""zero tax. They should be relieved, for continuing with the turnover tax would have effectively killed the business.

Not only was the level of tax envisaged completely irrational, the main players in this market""mainly banks, fund managers and dealers""also treat trading as a business income. Hence, they would not have benefited from a lowering of the capital gains tax.