What is Securities Transaction Tax?
Found this answer in Quora and could not resist sharing. Answered by Pramod Kumar.
He actually earned a profit of Rs. 607500 on the trade he entered 5 minutes before the close on expiry day.
He bought NIFTY Options for Rs. 0.05 which he rightly guessed would be ending In The Money.
It ended up in the money by Rs. 2.75.
He had bought 3000 Lots ( Lot Size- 75 )
His profit = ( 2.75- 0.05 ) x 3000 x 75 = 607500.
It was a success story up to this point.
The dream turned into a nightmare when he found to his dismay that he had calculated the tax implication wrongly.
Securities Transaction Tax :
This tax applies when you SELL shares, futures or options contracts.
On worthless options there is no tax.
On options which you square off it applies at 0.05 % of the premium.
In the present case if the option was squared off at Rs. 2.75 per share, the tax would have been Rs. 309.
But these were not squared off.
In the case of exercising of options ( or market settlement, as we call it ) , the tax is applied at 0.125% on the notional value of the option.
As the NIFTY had ended at 8602.75 , thus causing the value of 8600 Call to become Rs. 2.75, the tax liability was calculated as:
The value of transaction = 8602.75 x 75 x 3000 = 1935618750
STT at 0.125 % works out to Rs. 2419523.
If the transaction was settled by Mr. Gupta at the same price, STT would have been Rs. 309.
He ended up paying more than Rs. 24 Lakhs.
He did not lose it in the market.
This is important point to note.
The tax law took away his profit and then some more.
Why he could not settle it himself ? :
This point is getting lost in all the interaction on this topic and even in the petition being submitted to the Finance Minister by Mr. Chirag Gupta.
The trade could not be settled because there would not be any buyers at Rs. 2.75.
Markets do not give 55 times return in 5 minutes. ( Rs. 0.05 to Rs. 2.75 is 55 times )
The market participants know the tax implication and that is built into the pricing. At no point in last 5 minutes, the price would have been more than Rs. 0.05 or at best Rs. 0.10.
His tax per lot came to Rs. 806.41. He would have been profitable on NIFTY ending at 8611 or above.
Like he could assess that NIFTY will end above 8600 on expiry in 5 minutes from his BUY order, other parties had also assessed that it will not be going above 8610.
The final settled price is the weighted average price of the last 30 minutes of trading and not the actual last trade price.
So there was no price to settle in profit.
Hence, Mr. Gupta could not or did not square off .
Unfortunately he fell into what is called STT Trap.
The seller of option also must have suffered a similar loss. But as 3000 lots might have come from various sellers, the loss got spread and we are not hearing about it.
Edit: Seller will not have to pay tax as he sold the option prior to settlement.
(Correction suggested by. Thanks for correcting. )
All of us have fallen into this trap at times, but the transaction was for one or two lots, hence bearable.
Rs. 24 lakhs is a huge penalty to pay for ignorance of taxation rules.
All sympathies for Mr. Gupta but that is how the tax law is.
To Conclude :
He has suffered a bad loss of about Rs. 18 Lakhs and not 24 lakhs as suggested by the question.
The loss can not be called Stock Market loss. It is because of taxation.
I have written another answer to a similar question. You can read it here:
Thanks for reading.
The answer to the question was given by
Trader, Investor, Wanderer, Engineer– Many Hats To Wear
Civil Engineer by profession. Interests include Stock Market Trading, Options Trading, Travel, Politics, Fiction. Fascinated by our country India and her journey from the economy of shortages to aiming to become a cashless economy. Proud of diversity among the people and the common ethos that bind them together. Would attempt to answer the issues to the best of my knowledge and belief.
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