Tax Tornado hits Indian Stock Market

The NDA government has increased the taxes on those playing or investing in the Stock Market in this Union Budget (2024-25). The Indian Stock Market with about 16.22 crore Demat accounts seems to have become a fertile ground for the government to harvest taxes in this Budget.

The Union Budget has increased taxation on both Long Term Capital Gain (LTCG) and Short Term Capital Gains (STCG) from sale of equities. Government proposed to hike LTCG from 10% to 12.5% while STCG from 15% to 20%.

The rate of levy of Securities Transaction Tax (STT) on sale of Option in Securities is 0.0625% of the Option premium but the budget proposed to hike it to 0.1% of the Option premium. Also, the rate of levy of STT on sale of futures is hiked from 0.0125% of the Future traded price to 0.02%. This amendment is proposed to be made effective from the 1^st day of October 2024.  

As per budget documents, the government collected Rs 25,085 crore as STT in FY23. As per Revised Estimates, STT is pegged at Rs 32,000 crore for FY24 while government expects to mop up Rs 37,000 crore in FY25. Figures for LTCG and STCG are not publicly available.      

Reasons behind Government move

Today equity derivatives account for a staggering over 99% of Indian stock market volume. The number of active derivatives traders has increased ninefold from less than five lakh in 2019 to over 45 lakh currently. 

Currently, in most stock markets, derivatives volumes account for 5 times to 15 times of their cash market volumes. But in India, derivative volumes are more than 400 times higher than that of the underlying cash market. It has grown from 3 times in 2010 to 400 times in the last calendar year. The average daily turnover in equity futures/options on NSE has seen significant increase of 1.5x/18x over FY19-FY24.

Of late, the proliferation of derivative trading has become a major concern not just for the market but also from the sociological point of view as F&O trading for a majority of retail investors is presumed to be akin to gambling.

One of the reports by SEBI highlights that 9 out of 10 traders lose money, with approx Rs 56,000 loss per person on average. Retail traders on aggregate lost more than 80% of their bets.The SEBI report noted that approx. Rs 45,000 crore was lost by 90% of the participants while 10% of the participants earned Rs 6,900 crore.

The rise in taxes levied on derivative trading and short-term capital gains from sale of equities may have been a move by the government to curb the overwhelming amount of short-term trades in the stock market while also handsomely contributing to the government coffers, however, the market remains quite unaffected by the tax rise.

The Sensex fell 1,278 point just as the tax rise related to stock market transactions was announced in the Budget and plunged 1,542 points from the day high, but at the end of the trade day, the Sensex crept up to a fall of just 73 points, indicating the resilience of the market even in the face of the tax tornado.

Bank Deposits Vs Stock Market

One of the reasons for increased taxes on stock transactions may be the eroding Bank Deposits, which was the most popular form of savings for the Indian masses. In the last two fiscal years, Scheduled Commercial Banks saw a deposit growth of 13.4% (FY24) and 10.19% (FY23) respectively against Credit growth of 20.16% (FY24) and 15% (FY23). At the end of FY24, outstanding deposit of scheduled commercial banks stood at 212 Lakh Crore while outstanding credit was Rs 164.3 Lakh Crore.  

Market sources and socio-economic veterans point out that Indian households, especially the youth, are increasingly pulling away from traditional saving methods and investing in the stock market, which is detrimental to the Banking coffers of the country. The case in point is the Mutual Funds AUM as a percentage of Bank Deposits, which in March 2014 was 10% and increased to 27.9% in May 2024.

Several factors, including increased financial literacy and the Mobile App economy have contributed to the shift in investment patterns of the country. With the rise in inflation and the fall in Fixed Deposit rates offered by the Banks, the average investor understands that money put in the bank depreciates over time. With the rise in real estate prices, one of the more popular modes of investments, that is, buying real estate, has also become unaffordable for a majority of Indians. Under these conditions, the most lucrative investment is offered by the stock market, which has been breaking new records of highs, every year since 2020.

The market’s buoyancy despite higher taxes make it evident that the aficionados of the Stock Market see every fall as an opportunity to buy more. While the increase in taxes on stocks and derivatives transactions appear promising to the government coffers and seems to have no effect on the derivative trading frenzy, it is quite discouraging for the long-term investors who have become an endangered species of the stock market ecosystem due to the overwhelming number of those who are otherwise. Rise in Long Term Capital Gain (LTCG) tax is a cause of concern for value investors who entered the Stock Market to build long term wealth. It seems long term investors are being punished because of the market euphoria created by the majority who are in it for short-term gains.