Insights
Recent tax changes influencing derivative markets and investment patterns
April 24, 2023In a surprise move, the Indian government recently introduced two key tax changes that will likely impact the derivative markets and investment patterns in India.
First, in case of debt-oriented mutual funds, investors could previously benefit from long-term capital gains tax treatment on the gains realized from the sale of units held for a period exceeding three years in such mutual funds. With the change in law effective April 1, 2023, the government has provided that any gains realized on the sale of units of a debt oriented mutual funds (where equity portion does not exceed thirty-five per cent) will now be taxed as short-term capital gains (irrespective of the holding period of such units), i.e., at the applicable marginal rate (akin to ordinary income).
The overall impact being that such long-term capital gains that were previously taxed at 20 per cent with indexation benefits, can now be taxed at 30 per cent, leaving little tax-based incentive to invest in long-term debt funds. Notably, the withdrawal of long-term capital gains tax treatment will also apply to gold, international equity and even equity fund of funds (FoFs), which invest in other mutual fund schemes and/or in foreign shares.
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With respect to debt funds, it is speculated that the government intended to bring parity in taxation between returns from debt-oriented mutual funds and other investment instruments such as fixed deposits and other fixed income products. The underlying idea being that taxes should not have a distortionary impact on the decision to invest in fixed income products v. debt based mutual funds. Moreover, it may also be indicative of the policy perception that any return on debt has trappings of interest and hence ordinary income (and not capital gains).
Second, securities transaction tax (STT), which is payable on on-market sales of securities, was hiked for futures and options (F&O) as follows. For transactions involving sale of option in securities (where option is not exercised), the STT rate has been increased from 0.05 per cent to 0.0625 per cent. For transactions involving sale of futures in securities, the STT rate has been increased from 0.01 per cent to 0.0125 per cent. Market participants, in particular traders, speculators, hedgers and arbitrageurs, will have to bear the brunt of higher transaction costs in their trades. Further, trading volumes in F&O may witness a shift from futures to options as STT is levied on the premium amount only in case of options and not on the entire contract value as is the case for futures.
The revision of STT rates comes at a time when the number of demat accounts in India has surpassed the 100 million milestone. SEBI in a recent report highlighted that the total participation in the equity F&O segment has witnessed an increase of more than 500% in FY22, in comparison to FY19. Shockingly, 89% of such individual traders incurred losses in FY22. The increase in STT rates appears to kill two birds with one stone – it discourages the average retail investor from foraying into the F&O segment where a significant majority of them incur losses and at the same time increases the revenue collection from F&O trading. It also appears that the intention of the government is to encourage long-term delivery-based investing to bring about greater stability in the market.
It will be interesting to analyse the change in investment patterns of the Indian investor, pursuant to the significant changes brought about by the Finance Act, 2023 relating to securities transaction tax and taxation of mutual funds.
This article was originally published in Financial Express on 24 April 2023 Co-written by: Gouri Puri, Partner; Nimish Malpani, Senior Associate. Click here for original article
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Contributed by: Gouri Puri, Partner; Nimish Malpani, Senior Associate
Disclaimer
This is intended for general information purposes only. The views and opinions expressed in this article are those of the author/authors and does not necessarily reflect the views of the firm.
