FPIs, trading companies tap Sebi, centre for tax breather

The ongoing demand by Foreign Portfolio Investors (FPIs) and proprietary trading firms for a reduction in Securities Transaction Tax (STT) marks a critical juncture in India’s capital market policy. To understand the gravity of this issue, we must first trace the evolution of STT. Introduced in the Union Budget 2004-05 by then Finance Minister P. Chidambaram, STT was designed as a clean, efficient tax on securities transactions to curb tax evasion and replace the cumbersome long-term capital gains tax (LTCG) regime. However, in Budget 2018, the government reintroduced LTCG tax at 10% on gains exceeding ₹1 lakh, while retaining STT. This created a dual incidence of taxation — STT at the transaction level and capital gains tax at the income level — which foreign investors argue constitutes double taxation, especially since many jurisdictions do not allow credit for STT under their domestic tax laws or Double Taxation Avoidance Agreements (DTAAs). The key stakeholders here are FPIs, registered under SEBI (FPI) Regulations, 2019, who account for over 20% of daily trading volumes in Indian equities. They are joined by high-frequency trading firms and proprietary desks that provide crucial market liquidity. Their concern is amplified by the Reserve Bank of India’s 2023 circular tightening leverage norms for exchange-traded currency and interest rate derivatives, limiting intraday leverage to 5x and overnight to 2x. These rules, aimed at curbing speculative excess, have inadvertently increased the cost of hedging and market-making for FPIs. Combined with STT and capital gains tax, the effective transaction cost has rendered certain strategies unviable in India, prompting threats of relocation to offshore centres like GIFT City (Gujarat International Finance Tec-City), Singapore, or Dubai, where tax and regulatory regimes are more favourable. This shift poses significant risks to India’s financial architecture. A migration of trading volumes offshore would erode the tax base — STT collections alone exceeded ₹25,000 crore in FY23 — and diminish price discovery and liquidity in domestic markets. It would also weaken SEBI’s regulatory oversight, as offshore trades fall outside its jurisdiction. The government’s recent move to cut STT on government securities (announced in Budget 2024) signals recognition of this sensitivity, but equity and derivative segments remain untouched. Constitutionally, taxation of securities transactions falls under Entry 92A of the Union List (Seventh Schedule), empowering Parliament to levy STT via the Finance Act. Capital gains tax derives from Entry 82 (taxes on income other than agricultural income). The interplay of these entries underscores the Centre’s exclusive domain, but also the need for coherent policy to avoid unintended consequences. Internationally, this issue touches on India’s commitments under the OECD’s BEPS (Base Erosion and Profit Shifting) framework and its network of DTAAs, particularly with Mauritius, Singapore, and the Netherlands — key routing jurisdictions for FPI flows. Looking ahead, the government faces a delicate balancing act: maintaining tax revenues and regulatory control while preserving India’s attractiveness as a global investment destination. A calibrated STT reduction, especially on derivatives, coupled with rationalisation of capital gains holding periods and rates, could address the double taxation grievance without sacrificing fiscal prudence. The outcome will shape not just market microstructure but India’s broader ambition to emerge as a leading global financial hub under the vision of 'Viksit Bharat@2047'.