May 18: The government today scrambled to quell the rising panic in the market after it announced new criteria for a litmus test to distinguish between investment and trading income to rein in a growing tribe of carpetbaggers who have descended on India to skim profits off a surging market.
The government had spooked the financial institutional investors (FIIs) ' who have provided the ballast for the Indian bourses ' with its recent announcement of a modified litmus test to separate the long-term investors from mere traders.
The traders will have to pay a 41 per cent tax on the huge profits they make from short-term investments on the bourses. Profits from investments are treated as capital gains and taxed at a lower rate. The short-term capital gains rate is 10 per cent and is levied on investments that are held for less than 12 months.
The scare had broken out over a circular put out by the Central Board of Direct Taxes (CBDT) seeking comments from the public to help distinguish between a stock trader and an investor so that it could better tax them.
In an attempt to allay fears, finance minister P. Chidambaram today said no FII had been assessed as a trader.
“No FII has been assessed as a trader but as an investor because they have no permanent offices in India,” Chidambaram said when asked about the sharpest fall in the stock markets that was blamed on the new tax guidelines.
Finance ministry officials said the CBDT wanted to bring in 15 new ‘tests’ to distinguish between shares held as stock-in trade and shares held as investment in order to avoid the spate of litigations it has got embroiled in over the differing tax treatment for trading profits and capital gains.
“But this has nothing to do with genuine, normal FIIs. They will continue as before,” officials said. However, they added there were small ‘quickie’ funds which come in, book profits and vanish who could be considered traders.
“The FIIs have a long term stake in India. Many of them have made long-term investments in long gestation projects. The others have invested in the India story and are continuing to do so,” officials said.
As most of them do not even have offices in India, they have no way of offsetting profits here with losses or costs run up elsewhere, a favourite tax evasion trick followed by many Indian traders.
What the future holds
In Mumbai, there was a sense of d'j' vu over the market crash. The clarification by the ministry appeared to ease the worry lines. Many pundits said that the correction may continue but the markets would bounce back.
“While the global fundamentals have gone bad, Indian fundamentals continue to be strong. However, the technicals for both the global and domestic markets are now weak. Thus, there shall be extreme volatiliy in the Indian market in the near term. It is extremely difficult to predict the direction of the market at this juncture,” said Naresh Kothari, head, institutional equities, Edelweiss Capital.
“The market has been overbought, the futures and options (F&) positions have been substantial, recent IPOs have been aggressively priced and expectations were sky high,” added an analyst with a leading brokerage.
“There is scope for further corrections in the market. However, it will be difficult to predict whether they will be sharp or gradual ones. So while the market may go up 200 to 300 points in one session and people start rejoicing, it might again wipe out the gains in the next session,” said Kothari.
“It is absolutely unadvisable for people to try and trade in this market. One should select shares very carefully and should have the commitment to stick to it for longer term,” he added.