150% hike in futures STT, buyback tax spook markets; indices dip over 1%

Finance Minister Nirmala Sitharaman on Sunday proposed an increase in the Securities Transaction Tax (STT) on derivatives, signalling the government's intent to rein in excessive speculation in the futures and options (F&O) segment.

Sitharaman, during her budget speech, announced that the STT on futures contracts will be raised to 0.05 per cent from the existing 0.02 per cent, a hike of 150 per cent. "STT on options premium and on the exercise of options are both proposed to be increased to 0.15 per cent, from the current rates of 0.1 per cent and 0.125 per cent, respectively," she said in her budget speech.

India's benchmark indices Sensex and Nifty dipped following the budget announcement. Sensex plunged 2,370.36 points, or 2.88 per cent, to slip below the 80,000-mark to 79,899.42 during the afternoon trade. The 50-share NSE Nifty tanked 748.9 points, or 2.95 per cent, to 24,571.75. Recovering from the loss, Sensex and Nifty closed at 80,506.45 and 24,746.25, respectively. However, they were down 2.14 per cent and 1.96 per cent in the day.

The increase in STT is aimed squarely at high-volume and short-term derivative trading rather than the cash equity market, and is expected to substantially raise transaction costs for frequent traders and speculative strategies.

Market experts believe that the move could help discourage excessive speculative activity and promote a more balanced market structure. However, some caution that it may weigh on foreign portfolio investor (FPI) participation in the near term.

"The increase in STT, particularly in futures and options, is likely to act as a marginal negative for FPI flows, especially for high-frequency and derivative-focused global funds," said Aakash Shah, Technical Research Analyst at Choice Equity Broking.

According to Shripal Shah, MD & CEO, Kotak Securities, the steep increase in STT on futures and options, coming on top of last year's hike, is likely to raise impact costs for traders, hedgers, and arbitrageurs. "This could cool derivative activity and lead to a reduction in volumes. The intent appears to be volume moderation rather than revenue maximisation, as any potential revenue gain could be offset by lower derivative volumes," he said.

Buyback proceeds to be considered capital gains
In another significant move, the finance minister announced that proceeds from share buybacks will now be taxed as capital gains for all categories of shareholders.

Explaining the rationale, she said the change aims to discourage the misuse of tax arbitrage. Under the revised framework, promoters will be subject to an additional buyback tax, taking the effective tax rate to 22 per cent for corporate promoters and 30 per cent for non-corporate promoters.

"Change in taxation of buyback was brought in to address the improper use of buyback route by promoters," she said.

A buyback tax is levied on companies that buyback their own shares from shareholders. Generally, governments impose this tax to restrain firms from distributing profits to shareholders through share buybacks rather than paying dividends

Market experts believe that the higher tax burden on promoters may lead companies to reassess their capital allocation strategies between dividends and buybacks.

Roop Bhootra, Whole-time Director, Anand Rathi Share and Stock Brokers, said the proposed move is a positive for individual shareholders as tax liability reduces from 30 per cent (highest slab rate) to capital gains rates (short term 20 per cent and long-term 12.5 per cent) and negative for corporates and discourages buyback and pushes corporates to use reserves for capital expenditure and or R&D.

"Revamp of buyback tax framework, and the rise in STT (Securities Transaction tax)on futures and options will influence investor behaviour and short-term sentiments," Parizad Sirwalla, Partner and Head, Global Mobility Services- Tax, KPMG in India, said.