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Securities Transaction Tax (STT) not removed in budget 2009 – Good or bad for you?

The markets were hoping that STT would be abolished in this year’s budget. But it was not, and the markets weren’t happy.

But is removal of STT good for you as an investor? Let’s find out.



The stock market players were expecting that the Securities Transaction Tax (STT) would be abolished in budget 2009.

But it did not happen – the STT stays. The markets took this negatively, and reacted to this sharply.

So, is removal of STT good for you? Does STT help you – the investor, or is it bad for you? Read on to find out.

But let’s start with the basics.


What is Securities Transaction Tax (STT)?

STT is a turnover based tax, introduced in the year 2004-05. That is, instead of taxing a profit, STT is a tax on the value of shares bought and sold on a stock exchange (irrespective of your profit or loss).

STT is levied on the total volume of transaction of shares, units of mutual funds (MFs) or derivatives. The current rate of STT is 0.125% of the transaction volume.

Characteristic of STT

As mentioned earlier, STT is a tax on the turnover, irrespective of the profit or loss involved. That is, you must pay STT even if there is no profit.

Securities Transaction Tax (STT) and exemption of Long Term Capital Gain (LTCG)

As you must be aware, any Long Term Capital Gain (LTCG) from the sale of shares on which STT has been paid is exempt from income tax.

(Please read “Long Term and Short Term Capital Gain – Income Tax Calculation” for more)

Thus, LTCG exemption and STT are inherently linked.

This means that if STT is removed, the LTCG exemption linked to it would also go away. The tax on LTCG would be reintroduced, and you would need to pay income tax on any LTCG from stocks or MFs.


Implications of removal of STT

Ok, now that we have the background, let’s see what removal of STT would have meant.

For traders

For people who buy and sell stocks frequently (traders), STT was a big irritant. They have to pay this tax on every single transaction – even if they don’t make a profit!

And since these people make profit by selling as soon as the price goes up, they aren’t too concerned about long term capital gain – these are the people for whom gains are almost always short term!

Thus, traders are the ones who are suffering because of the STT, and they would have been the ones to benefit tremendously from the removal of STT.

And since traders make up most of the stock market, their collective voice is heard loud and clear on the street! That’s why when the STT was not removed, these traders were disappointed and the markets reacted negatively.

For investors – YOU

Now, the scene it totally different for a genuine investor – what you should aim to be.

(Please read “Stocks – The winning bet for the long term” for more)

An investor doesn’t buy and sell frequently – he is a buy-and-hold person. He goes by the merit of the company’s operations, and not by its short term stock price movement.

(Check out “Want to own a company? Buy stock!” for more on this)

Thus, although STT needs to be paid on every transaction, an investor wouldn’t suffer much because of his low trading volume.

On the other hand, since an investor adopts a buy-and-hold strategy, his gains are almost always long term. And since there is no tax on LTCG (due to the STT already paid), he benefits tremendously.

Remember, profits for a buy-and-hold investor can be huge, which means that any tax on it would also end up being a big amount!


Conclusion

A genuine investor trades less and has most of his profits as long term capital gain (LTCG). Thus, unlike a trader, removal of STT would hurt him hard.

A genuine investor like you and me should cheer the continuation of the Securities Transaction Tax (STT) – and the corresponding continuation of exemption of long term capital gains (LTCG).

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