Budget's STT hike on F&O delivers a double-engine blow to investors

In a move set to raise the cost of derivatives trading, Finance Minister Nirmala Sitharaman has announced a hike in the Securities Transaction Tax (STT) on Futures and Options (F&O) in the Union Budget for 2026-27. The levy on futures has been increased from 0.02 per cent to 0.05 per cent, while the tax on options premium and options exercised has been increased to 0.15 per cent from the present rates of 0.10 per cent and 0.125 per cent, respectively.

The increase in STT is applicable only for derivative trades and not for other cash-market transactions.

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Market participants had been expecting some relief in capital gains taxation, believing that such a move would boost investment, improve productivity, and support economic growth. Instead, the proposed measures have disappointed investors, and equity markets have reacted negatively to the budget announcements.

Purpose explained

Based on the press conference following the Budget, Sitharaman and her team revealed that the primary purpose of hiking the STT on F&O is to discourage high-risk, speculative trading by retail investors and to manage systemic risks in the derivatives market.

Key purposes highlighted in the press conference and Budget speech include:

Protecting small investors: The minister said the government cannot remain quiet while small investors face huge losses in the speculative F&O segment, prompting a need to "deter" or "discourage" them.

Controlling high-volume speculation: The hike is targeted at curbing the massive surge in retail participation in "betting-style" derivative activity, rather than impacting long-term equity investment.

Managing systemic risk: Revenue Secretary Arvind Shrivastava explained that the increase in STT aims to handle systemic risk in the derivatives market.

Providing a 'course correction': The measure is seen as a necessary correction to shift focus away from excessive short-term churning and towards sustainable market dynamics.

The hike is specifically directed at F&O, with the government indicating that it's "not against" derivative trade, but wants to reduce the dangerous levels of speculation.

Original intent behind STT

Finance ministers may come and go, but the government’s role in financial administration is one of continuity. While every government has the right to modify tax policy based on prevailing needs, certain foundational principles should not be compromised.

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Capital gains taxation on equity investments is one such principle. The current approach has not only disappointed investors but has also weakened confidence in the government’s budgetary assurances.

To understand how we arrived at this point, it is necessary to revisit the Union Budget of 2004, when the STT was first introduced.

In his Budget Speech for 2004–05, then Union Finance Minister P Chidambaram articulated the rationale behind STT. He acknowledged the complexity and enforcement challenges of capital gains taxation in capital markets and proposed a structural shift. Long-term capital gains (LTCG) tax on securities was abolished altogether and replaced with a small transaction-based tax collected at source through stock exchanges.

Short-term capital gains tax was reduced to a flat 10 per cent. STT was intended to offer
a) Simpler tax collection

b) Certainty of revenue

c) Lower litigation

d) Greater transparency through exchange-traded transactions

It was explicitly designed as a substitute for capital gains tax, not an additional levy.

Evolution and deviation

Between 2004 and 2008, STT rates were adjusted several times, particularly for derivatives, as taxation structures were refined. Revenue from STT grew rapidly alongside market expansion.

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In 2008, STT was extended to commodity derivatives, though this was rolled back later in 2013 and replaced with the Commodity Transaction Tax.

The real policy shift occurred in 2018. Through the Finance Act of that year, the then Finance Minister Arun Jaitley reintroduced LTCG tax on equities while retaining STT. This marked a clear departure from the original policy intent.

Since then, successive finance ministers have continued this anomaly. The government benefits from substantial STT collections — automatically collected and remitted daily by stock exchanges — while simultaneously taxing capital gains, which investors must declare and pay through their income-tax returns.

Cost to investors

STT collections from April 1, 2025, to January 11, 2026, are estimated at Rs 44,867 crore. The Budget aims to generate additional revenue, with STT collections from the F&O segment estimated to reach Rs 73,700 crore in FY27.

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If the purpose of the present increase in STT on derivatives is to reduce speculation in the derivative market, then why is there no incentive to cash market participants by the reduction of STT for cash markets? Hence, the aim of tinkering with STT is just to generate more income for the government.

We have to wait and watch to know the impact of this. A reduction in the derivative market may reduce depth and liquidity in the market, which may also affect the cash market. While the ruling party often advocates the concept of a “double-engine sarkar”, the combination of capital gains tax and STT has effectively become a double-engine blow to investors.