A telephone handset sits on a desk while on the trading floor in London, U.K. (Photographer: Jason Alden/Bloomberg)

Budget 2019: New Stamp Duty Proposal May Land A Hard Blow To Proprietary Trading 

The union budget for financial year 2019-20 has ushered in a paradigm shift in how stamp duty is levied on transactions involving financial instruments such as equity shares and derivatives. A shift that may curb avoidance but will also add to trading costs and one that may be debilitating to proprietary trades by brokerages.

Currently stamp duty rates on such financial transactions are determined by each state with as many as 20 different rates levied across the country. The stamp duty is paid when a contract is created for the trade executed by a broker at the behest of the client.

While multiple stamp duty rates across states are one point of confusion, the biggest issue so far has been the collection of the tax which is the responsibility of the broker who collects it along with the trading commission. The tax is paid to the state in which the client is domiciled.

Now, as per the Finance Bill, states can no longer charge or collect stamp duty on

  • Issue of securities that create or change the records of a depository.
  • Transfer of securities by the depository.
  • Sale of securities when made through the stock exchanges.

“The obligation to collect the stamp duty on behalf of the state government has been cast on stock exchanges, clearing corporations authorised by the stock exchanges and depositories, as the case may be,” clarifies a note by law firm ELP.

The Finance Bill has specified new stamp rates on transfer of securities on a delivery basis, non-delivery basis and equity, commodity, currency and interest rate derivatives among other instruments.

(Image: Finance Bill)
(Image: Finance Bill)

The implications of these changes are three-fold:

  • Stamp duty rationalisation will reduce confusion and ease collection.
  • Some transaction costs will rise.
  • That increase in costs may be a blow for proprietary trades.

1. Less Confusion, Easier Collection

The levy of a uniform stamp duty on all buyers in such financial transactions, versus multiple rates on both sides of a transaction, will usher in a simpler regime.

Tasking stock exchanges to collect the tax and distribute it to the states based on the domicile of the buyer will help smoothen the process and curb tax avoidance.

Operationally, this is a good move as brokers were submitting stamp duty in multiple states and sometime in multiple cities within a state, said Deena Mehta, managing director of Asit C Mehta Investment Intermediates Ltd.

2. Some Equity Transaction Costs To Increase

A quick comparison between the proposed rates and existing rates across states shows that transaction costs will fall overall but will rise for buyers in the case of trades involving delivery of shares.

For instance, Maharashtra and Delhi both charge 0.010 percent on equity delivery transactions on each leg versus the budget proposal of 0.015 percent to be paid only by the buyer. That means currently in a delivery-based transaction the buyer pays Rs 1,000 per crore of trade value as does the seller. That’s a total stamp duty cost of Rs 2,000 on the full transaction. If the budget proposal is finalised, only the buyer will have to pay Rs 1,500 per crore of trade value. Overall stamp duty costs on the transaction will decline but buyers will pick up a bigger bill.

In the case of derivative transactions both states levy a 0.002 percent stamp duty on each leg of the transaction versus the budget proposed rate of 0.002 percent on futures and 0.003 percent on options, payable only by the buyer. That indicates a decline in overall costs though a buyer of options will have to pay more duty than he currently does.

Six states including Andhra Pradesh, Telangana and Haryana compute the tax differently and have capped it at much lower rates than proposed in the Budget. But trade volume in these states is minuscule anyways.

3. Big Blow To Proprietary Trades

A proprietary trade is one in which a broker trades on his account instead of a commission or trading on behalf of a client. Since a contract cannot be created by a broker undertaking a trade for himself, many states currently impose a flat fee on the trade undertaken on the broker’s proprietary book, also commonly referred to as ‘prop book’.

The biggest impact of the stamp duty provisions is the potential rise in proprietary trade costs. The Finance Bill 2019 does not clarify what rate of stamp duty would be applicable for proprietary trades.

Brokers fear that the rates that apply to their client trades may also apply to prop book trades. If that were to happen tax costs would go up as much as seven times for delivery-based transactions and close to double for others.

Market-Wide Impact

Role of Proprietary Trade

Proprietary trade forms a big component of daily trading turnover on the stock exchanges. According to the January bulletin of the Securities and Exchange Board of India, the share of proprietary trade in the cash market stood at 21.4 percent of NSE’s total turnover and 22.6 percent of BSE’s total turnover for the nine months ended December 2018. The share of proprietary trade in the equity derivatives market stood at 38.7 percent of NSE’s total turnover and 76.41 percent of BSE’s total turnover in the equity derivatives for the nine months ended December 2018.

Several brokers BloombergQuint spoke to said on the condition of anonymity that the increase in stamp duty rates on proprietary trade could hit the trading turnover in the equity market as it will no longer be viable to trade with such high transaction costs. Many brokers undertake arbitrage trades on thin margins while others undertake high frequency trade through their prop books. The increase in stamp duty burden will impact arbitrage trading and high frequency trades.

Further, the impact on trading turnover will increase the buy-sell spreads in the market thereby reducing liquidity in the market. The brokers expect industry body, the Association of National Exchange Members of India, to make a representation to maintain the same stamp duty rates for proprietary trades.

The rates proposed in the budget don’t have a provision for proprietary trades unlike Maharashtra where there’s a different rate for such trades, Mehta said. “It could be a miss or someone may not have applied their mind on this issue. I am sure it can be corrected with adequate representation.”