A rollback was inevitable for capital markets. Mr P. Chidambaram has rolled back the turnover tax on securities partially and, in the process, made the system more complicated with differential rates. The apparent logic being a segmentation of intermediaries subject to capital gains tax and those who pay income tax on business profits. Mr Chidambaram’s earlier argument that there shouldn’t be differential taxation in securities has gone for a six. There is also a revenue loss, with revenue from this tax expected to drop from Rs 7,000 crore in 2004-05 to around Rs 1,000 crore. But greater volumes may very well compensate. In the differential system, day traders and arbitrageurs will pay 0.015 per cent and derivative (futures and options) traders 0.01 per cent. Debt traders will be exempted and not only has the Sensex reacted favourably, but prices in long-and medium-end government securities have also shot up. This is sensible, because the debt market works on very thin margins. However, delivery-based equity trading, accounting for not more than 25 per cent of transactions, will continue to attract 0.15 per cent, with tax shared equally by buyers and sellers. But in effect, investors will have to pay both sides of the tax, since anything paid by a mutual fund will be reflected in expenses and thereby alter the net asset value.

Most foreign institutional investors belong to the delivery category. Long-term capital gains will be zero if transaction tax is attracted and the short-term capital gains tax will be 10 per cent and this levels the playing field between equity and non-equity mutual funds. This is in line with budget proposals, with the rate now modified and differentiated. But the usual capital gains regime (35 per cent on short-term and 20 per cent on long-term without indexation) will apply if transaction tax is not attracted and this applies to non-equity mutual funds as well as debt. In another proposal, day traders, arbitrageurs, derivatives traders and delivery-based equity transactors can take credit for tax paid on business tax on profits. However, this will clearly work only for the more efficient day traders, although as a concession, this is a major one, as this covers speculative profits also. Equity-based mutual funds will, in all probability, witness short-term investor inflows and to discourage short-term exit, some exit load (unlike 0 per cent now) is certain. There may also be a hike in entry loads. There is still some lack of clarity about how the transaction tax will be distributed between the buyer and the seller of a mutual fund unit. But for the moment, the United Progressive Alliance government has recognized capital markets are important.