How STT Became A Tax On Market Confidence

One of the core principles of taxation is to avoid double taxation, writes Balwant Jain.

Markets swung sharply in early February as investors reacted first to the Union Budget and then to a breakthrough in India-US trade relations.

On 1 February, the Sensex tanked and closed 1,547 points lower, with the sharp sell-off largely driven by investor concerns over the government’s move to raise Securities Transaction Tax (STT) rates in the Union Budget.

STT is imposed on the purchase, sale, and derivative trades of equity products. A contentious levy in India's financial markets, I explain its origins, examine its impact, and argue why it is time for the government to consider withdrawing it.

When STT Became Double Taxation

STT was introduced in India by the then Finance Minister P Chidambaram in Budget 2004-05. It was made effective from 1 October 2004 in lieu of which long-term capital gains (LTCG) on listed equity shares and equity-oriented schemes were made fully tax-exempt.

STT is levied on all the transactions in equity, irrespective of whether the transaction results into profit or loss. In comparison, the tax on LTCG is payable only when there is a profit.

The STT rates have been changed and increased over the years.

The exemption on LTCG for listed equity shares and units of equity-oriented schemes remained in place until 2018, during which period STT was levied and served as a proxy for LTCG tax for listed equity products. The gross collection of STT for financial year 2024-2025 was around Rs 52,200 crore, as per the Central Board of Direct Taxes (CBDT) data.

However, a flat tax at 10 percent on LTCG beyond Rs 1 lakh was introduced in 2018, while retaining STT on all these transactions. At the same time, a flat rate of 15 percent was made applicable on short-term capital gains (STCG). 

Retaining STT while reintroducing LTCG creates overlapping tax burdens and raises policy questions about fairness and investor incentives. It was wrong on the part of the government to go back on its words. This also amounts to nothing but double taxation of the same amount.

One of the core principles of taxation is to avoid double taxation.

Continuing to levy STT while simultaneously taxing LTCG runs counter to this principle. Taxes on both long-term and short-term capital gains have since been increased further in Budget 2024-25, intensifying the burden on equity investors.

Higher STT Won’t Cure F&O Speculation

While higher STT is aimed at curbing retail speculation in derivatives, evidence suggests it won’t deter risky behaviour. Instead of raising transaction costs, the real solution lies in investor education, tackling trading addiction, and encouraging long-term equity investing.

The primary reason for increasing STT rates is curbing excessive speculation in the derivatives market by retail investors, as clarified by the Revenue Secretary. Yes, it is a fact that retails investors are indulging in excessive speculation and losing their hard-earned money. As per the data released by the Securities and Exchange Board of India (SEBI), around 93 percent of individual traders in the equity derivatives segment incurred net losses.

The stated purpose may be true but there are other measures to curb speculation.

In spite of taxing sin goods such as tobacco and alcohol at higher rates, there is no proof of any reduction in demand for such goods. Just like increased taxes on sin goods did not reduce its consumption, higher STT on futures and options (F&O) will not deter retail investors.

Instead of taxing F&O transactions more heavily, the government needs to address the underlying addiction. It is the lure of quick money that draws retail investors to the derivatives segment, and such behaviour is rarely deterred by higher transaction costs.

The government should instead incentivise the retail investors to invest long term by eliminating double taxation of the equity market. The market regulator and stock exchanges may aggressively educate the retail investors about the pitfall of F&O trading with real numbers taken from real-life example.

Punishing Markets to Curb Few Traders

The F&O segment is a very important component of the equity market, providing stability and liquidity in the market.

Increasing STT rates for F&O transactions will increase the transaction cost, thus adversely impacting the equity markets.

The fact of the matter is that retail investors alone do not participate in the F&O segment. There are other players like arbitrage funds, proprietary trades, and foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) who are active participants in this segment.

The retail traders constitute less than one-third of the F&O turnover on the National Stock Exchange (NSE). Just to discourage one-third of the participants, the government wants to penalise the remainder two-third of the equity market by depriving them of the hedging opportunities and adequate liquidity in the market. 

The arbitrage funds offer tax-efficient investment avenue for parking short-term funds as compared to liquid funds. The arbitrage funds hedge their transactions through F&O. An increase in the STT rates is likely to kill the arbitrage fund as a category in the long run.

Market experts expect the returns of arbitrage funds to come down by 30 basis points, making it less lucrative. Higher STT will also increase the cost of the genuine investors who wish to hedge their transactions.

Markets Need Trust

The stated objective of successive governments has been to develop and cultivate an equity culture in the country by building a vibrant equity market. However, recent policy actions appear to run contrary to this goal.

Overall, the equity products on which STT is levied are taxed more than other capital assets. LTCG on various investments products like hybrid funds, gold and silver ETF, gold and silver funds, real estate, and bullion are taxed at a flat rate of 12.5 percent. The LTCG on listed shares and equity-oriented schemes are also taxed at a flat rate of 12.5 percent, with an additional cost of STT resulting into increased cost of transactions. 

The rupee has depreciated by around 9 percent during the last two years. Major outflow of FIIs during this period is one of the reasons. The trend of continuous outflow of FIIs need to be reversed. Significant depreciation of the rupee impacts the dollar returns of FIIs, making Indian equity less attractive. Moreover, the FII invests in any country on the basis of trust in the promises made by the government to the investors.

To bring stability to the equity market and enhance its credibility, the government must revisit STT. Ideally, the levy should be removed altogether to restore investor confidence and encourage both foreign and retail participation. If that is not feasible at the moment, the government should at least roll back the recent increase in STT rates.

One can only hope that the Finance Minister is listening.

(Balwant Jain is a tax and investment expert. This is an opinion piece and the views expressed are the author's own. The Quint does not endorse or is responsible for them.)