Global Cues Push Indian Markets To Record Closing Highs
The stock markets picked up pace again as a gentle tailwind lifted both the BSE Sensex and NSE Nifty50, settling at record closing highs on Thursday
On Episode 353 of The Core Report, financial journalist Govindraj Ethiraj talks to Sachin Menon, senior tax consultant and former partner at KPMG as well as Rajesh Baheti, managing director at Crosseas Capital Services.
Our Top Reports For Today
SHOW NOTES
(00:00) The Take: Trigger Happy Tax Officials
(04:41) Global cues push Indian markets to record closing highs
(07:11) GST data is better for July and the numbers are being announced once more
(08:38) Maruti’s record growth is fuelled by customers buying CNG cars, with 1/3rd of cars running on them
(10:39) High pitched tax assessments like Infosys, the case and impact
(20:19) Did online discount brokerages trigger the explosion and thus scrutiny of India’s derivatives trade?
NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regards any feedback, you can drop us a message on [email protected].
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Good morning, it's the 2nd of August and this is Govindraj Ethiraj, headquartered and broadcasting and streaming from Mumbai, India’s financial capital.
The Take: Trigger Happy Tax Officials
Think of the tax official as a senior sales manager, in lets say, a firm selling air conditioners or colour TVs.
His or her job is to sell the maximum number of colour TVs to which is linked is her or her performance grading and of course a bonus at the end of the year.
Substitute the sales manager with an income tax official. He has similar targets and his job is to look for the infractions of law in various companies and build a case which usually involves the highest amount of possible tax.
After all, his job by collecting more taxes is to help the Government earn more revenue. And more taxes also means, at least in theory, more or better quality of services for you and me.
The tax fraternity calls these high-pitched assessments. Which means that tax officials build cases involving almost impossible tax demands which usually go and die, quite literally because the demands get struck down or diluted in appeals or in courts.
There is a cost to this.
Companies have to, as in the case of Infosys which we will come to, spend time and effort fighting back, including in some cases, dashing to court.
So Reuters is reporting that tax officials could issue notices soon to more major IT services firms in an investigation of alleged tax evasion related to work done by their overseas offices, a day after Infosys was slapped with a $4 billion tax demand.
In serving its highest-ever tax demand on Infosys, the government accused India's second-largest tech services company of evading taxes and sought 320 billion rupees ($3.8 billion), or almost all its revenue for the quarter ended June 30.
The National Association of Software and Service Companies (Nasscom), the industry lobby group was quick to issue a statement and said the tax demand "reflects a lack of understanding of industry's operating model", and that companies are facing avoidable litigation, uncertainty, as well as concerns from investors and customers due to such actions from the government.
"The government circulars issued... must be honoured in enforcement mechanisms so that notices do not create uncertainty and negatively impact perceptions on India’s ease of doing business," it said in the Reuters report.
Infosys said late on Wednesday it had received "pre-show cause" notices from the tax authorities but believed the relevant taxes had been paid.
The company said it had paid its dues and is in compliance with all regulations.
The overseas offices carry out projects for Indian IT firms and provide services to international clients, among other functions.
The broader logic is quite simple.
If Infosys is exporting services, it is entitled to not pay tax whichever way you treat an income incurred in an overseas branch.
The tax department evidently feels if the overseas branch has rendered a service to the head office in India, then a tax must be paid.
It is not clear to me how but we will come to that shortly.
Reuters points out that in the last year, India's goods and services tax department has sent more than 1,000 notices to companies, including Life Insurance Corporation of India, Dr Reddy's Laboratories and Ultratech Cement.
Tax authorities have also issued notices to online gaming companies demanding a total of about 1 trillion rupees or Rs 100,000 crore in taxes that they have allegedly evaded.
It is quite obvious that a lot of this will never materialise. It is also worrying in some way that online gaming companies fall into the same target group as Infosys, given that such organisations should attract high sin taxes and thus be restricted in terms of who they sell their services to.
Even if everyone knows that these tax assessments or demands will not materialise, valuable top management time will go in responding to the notices and to questions about those notices, including from media organisations like us.
Think about it from the other side as well. As the principal sitting in let's say USA, I may be hesitant or worried if my vendor, a leading IT services company, is likely to spend management time fighting such large tax cases.
Tax officials have been doing a good job in expanding the tax net and also going after offenders, as in the case of goods and service tax.
They must of course focus on areas where there is evasion and the cases are more open and shut.
Elsewhere, they must strive for more balance to find as well.
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Markets
The stock markets picked up pace again as gentle tailwind lifted both the BSE Sensex and NSE Nifty50, settling at record closing highs on Thursday.
The Sensex earlier hit an all-time high of 82,129.49 intraday before closing up 126 points to 81,867, while the Nifty50 ended 10 points above the 25,000 levels at 25,010.
The Nifty hit a record high in trade on Thursday at 25,078.30.
The big movers, according to Business Standard, were Power Grid Corporation of India, Coal India, ONGC, HDFC Bank, and Dr Reddy's Lab with gains of up to 4 per cent. Some 28 of 50 Nifty companies ended higher.
Interestingly, the MidCap and SmallCap indices were down, though marginally, possibly because investors are selling as well.
One reason for the bullishness was the prospect of a U.S. interest rate cut in September which would likely trigger foreign inflows into domestic equities.
Speaking of US and Wall Street, analysts have bought back into the Nvidia hyper growth story, for now, or this week at least.
Nvidi shares were up 13% Wednesday after remarks from top customer Microsoft and rival chipmaker AMD said there wouldn’t be a slowdown in the multibillion-dollar buildout of AI servers based around GPUs.
Microsoft CEO Satya Nadella and finance chief Amy Hood said Tuesday the company plans to spend even more on Nvidia-based infrastructure next year, CNBC reported
Nvidia has been a key beneficiary of the AI boom. Its stock has doubled so far in 2024 and is up more than 500% since ChatGPT’s release in November 2022 when the world woke up to this new technology phenomenon which of course promised to have turned the world upside down by now.
Which of course has not happened, at least so far. And that was metaphorically speaking either way.
Morgan Stanley analysts named Nvidia a “top pick” in a note on Wednesday, saying that concerns including competitive dynamics, export controls and supply chain concerns are likely to “fade with time.”
Meanwhile, on interest rates, The Bank of England cut interest rates from a 16-year high on Thursday.
The BoE will reduce borrowing costs by a quarter-point to 5.0%.
This is the first cut in rates since March 2020, at the start of the COVID-19 pandemic.
GST Data is Released Once Again
Meanwhile, Gross GST collections rose 10.3 per cent in July to over Rs 1.82 trillion, according to official data released on Thursday.
THe news is also that they have been released after the data was not announced formally but released selectively, mostly because the figures were lower.
Right now, net Goods and Services Tax (GST) collection after accounting for refunds was over Rs 1.66 trillion, a growth of 14.4 per cent.
Gross revenues from domestic activities grew 8.9 per cent to Rs 1.34 trillion in July. The GST revenue from imports jumped 14.2 per cent to Rs 48,039 crore.
GST revenues had hit a record high of Rs 2.10 trillion in April 2024, the Business Standard reported.
Oil Prices Rise
Elsewhere, oil prices rose again after Iran was reported to have ordered a retaliatory strike on Israel for killing a Hamas leader on its soil, Bloomberg reported.
Brent crude was quoting over $81 a barrel.
Bloomberg reported that the fresh tensions in the middle east has led to a flurry of activity in the oil options market.
Traders are also waiting for OPEC’s decision in the coming weeks around the pace at which it unwinds its cuts, and of course the Chinese demand
How Cheap CNG Is Driving Maruti’s Sales
One out of every three car models sold by the country’s biggest carmaker Maruti Suzuki was powered by CNG, the company revealed in a post-earnings call on Wednesday.
Moreover, this is the first quarter where CNG sales outpaced diesel across the passenger vehicles segment.
Driving a CNG vehicle could cost upto 40% less compared to a petrol car but that is a very rough calculation.
Overall savings could result only if you drive beyond a certain amount since you pay more for CNG cars and of course you can live with valuable boot space sacrificed to a gas tank.
Maruti sold close to 150,000 CNG vehicles in the first quarter of this year, including some of the relatively higher end models.
A research report from ICICI Securities says CNG mix was previously hit by supply side disruptions but is now standing at 33% or one third, compared to around 27% last year.
The interesting factor from the Maruti results is that 42%of buyers are first time buyers while additional car buyers are at 38% and replacement demand is at 20%.
A good CNG mix, ICICI Sec says, will help Maruti Suzuki deliver higher margins.
Speaking of cars
Tata Motors Ltd.'s first-quarter profit rose, beating analysts' estimates, driven by a surge in sales of British subsidiary Jaguar Land Rover.
The consolidated net profit of the Nexon maker rose 72.4% year-on-year to Rs 5,692 crore in the three months ended June, on the back of revenue that rose 5.7% to Rs 1,08,048 crore, according to an exchange filing on Thursday. Analysts polled by Bloomberg.
The Infosys GST Tax Case
Returning to Infosys, the country’s second largest IT services company, received a goods and services tax (GST) demand of ₹32,403 crore.
This demand is related to services availed by Infosys from its overseas branches over a five-year period starting in 2017, said a Reuters report.
The tax document details that Infosys paid consideration to its overseas branches in the form of expenses.
Consequently, Infosys is deemed liable to pay Integrated Goods and Services Tax (IGST) under the Reverse Charge Mechanism (RCM) on these supplies, amounting to Rs 32,403.46 crore from July 2017 to 2021-22.
The RCM system mandates that the recipient of goods or services, rather than the supplier, pays the tax.
In an exchange filing, Infosys stated that it has settled all dues and maintained that GST is not applicable to the expenses claimed by the DGGI. "Infosys has paid all its GST dues and is fully compliant with central and state regulations on this matter," the company asserted, according to the Reuters report.
For a better understanding, I spoke with Sachin Menon, Senior Tax Consultant and former KPMG Partner and began by asking him how tax liability worked for export oriented companies.
INTERVIEW TRANSCRIPT
Sachin Menon: So this is a news item today in most of the papers that Infosys slapped with the notice of 34,000 crores for the demand from GST authorities before we are coming to any conclusion about the liability which is being slapped on them, let us understand that how this software export companies operate in normal course, they're good. There are different business models which the different companies for, but as of now, from whatever may be those media news and whatever is reported, I can't fathom what is the model which they are for like but normal course, the way this software companies having huge export orders from countries like us or for the euro structure, is that they normally have some branches in those companies for various reasons, because when they are sending the IT professionals from here to US or Europe, there are so many formalities, like they have to have an office there for administrative reasons, Visa purposes, etc. So normally they open a branch there, and the employees traveling from here will be going to the branch, and they would be executing those engagements from there or the client side. That's the case may be now, and I understand that this branches also provide the on site services to the customer while they are executing their software contracts, and then enforces food, the expenses of the salary and the order expenses, rentals, etc, for running a branch office in such locations. So normally, what happens is that the contract is executed. Infosys bill the US client. After the contest executed, they get their money, and that is considered to be declared in the GS return as export of services at the same time the expense side, you know, for maintaining the office, they make remittances with reference to their salaries or at expenses or transportation, Visa processing, etc, etc. Now, the Department's view seems to be that when enforces is sending the money for the branch expenses or overhead expenses, in fact, such branches are considered under the GST law as distinct persons and the as per the law, any transaction between the head office and the branches would be subject to GST. So their argument is that whatever money they are funding the branches for the day to day functioning, etc, is nothing but a consideration for service received by the Infosys India, and therefore those expenses for the last five years, Infosys is supposed to pay GST, and since they have involved section 74 which is suppression, mis, declaration, concealment, etc, that five years they will have to calculate what could be the demand amount and 18% interest plus penalty. That seems to be this amount of 34,000 crores, 34,400 crores, or something which they are talking about. So this is the brief picture of what would have happened, some variations in that model, etc. But this is generally what is being seen.
Govindraj Ethiraj: You're saying, despite the fact that the income for the entire project is in the form of an export, what you might incur underneath that in these payments to, let's say, the branch for various activities, could draw or could attract local goods and services tax.
Sachin Menon: Yeah, it would be considered as import of services, and therefore a reverse charge mechanism under which they have to pay. They can raise a self invoice and make the payment file returns and show that that's what the Department says.
Govindraj Ethiraj: And what's your sense on how strong this case is?
Sachin Menon: So first and foremost is that there is old service tax cases, because there is no much of a difference of this model during the service tax regime and now. And even whereas the legal provisions are also copied from the service tax law and pasted in the GST law. So there is no much of a difference between the legal position under service tax law as well as the GST law. So during that period of time, there was some orders. I think it is in the case of Infosys already that such reimbursement such expenses is not for receiving any service I am. Funding an office, branch office, and I am paying my already expenses and other salaries or whatever, which is supposed to be incurred at the branch level. It is not for any receiving any import or service, but it is actually normal expenses, administrative expenses for a branch. First question is whether there is any any service at all, even if we argue that there is a service, then the point is that number one is that the input credit is fully available once you pay reverse charge mechanism, if enforces pay 18% GST, then immediately Infosys is eligible to take the credit of that tax, what they paid or and claim a refund of that as an export incentive. They are eligible to get the refund of whatever may be those input taxes incurred. So it's a zero sum game as far as the government is concerned, but and for, and for, most importantly, the government recently clarified, as recent as 26th of June, 2024 by the circular number 210 they clarified that in the case where the distinct persons so there is a terminology used for branches and the simple relationship they call it as a distinct person in such a transaction where the head office endured some expenses to the branch, and the branch is eligible to take The pull of such tax, which is payable in such case, one thing is that you can raise an invoice on the branch and charge GST etc, add the market value plus plus 10% or whatever. And if you are not doing that, then, as per this provisions of GST law, whatever may be, the amount payable you are mentioning will be accepted as the value for the services, so provided. And it's also clarify that in case of import of services, also in case if there is no such invoice are raised, then it should be deemed to be the value of such services deemed to be nil, and therefore they need not make any payment. It is accepted. So that circular also is actually totally negating this demand it is issued. So to me, privacy, it looks like a kind of a storm in the tea cup. It make successional giving a 34,300 crore worth of demand slapped on Infosys, etc. So the media can say, you know, go gaga about it, discussing about it, etc. Department, the officers are very, very happy about slapping such notices and finding out some ways to interpret the law the way they understand it, but ultimately, I think this would be, this would go to the adjudication level. According to me, Infosys is on a very strong footing as far as this case is concerned.
Govindraj Ethiraj: Thank you so much for joining me.
Sachin Menon: Thank you.
The Perils Of Futures And Options Trade
There has been much discussion on futures and options trade.
The noteworthy statistic is that 9 of 10 individual traders in equity futures and options, lose money at a net level.
Many traders, as we have discussed, are young and have likely borrowed money to fund this trading.
Many realise only once fully entrenched that they are also subject to high transaction costs.
Much of this explosion in activity, as we have discussed again, has been driven by the ease of opening trading accounts and then diving into the derivatives universe.
Quite simply, as we have argued earlier, there is a need for greater friction in such transactions, including for the opening of these accounts.
Rajesh Baheti of Crosseas Group joins me now to talk about what is wrong with F&O in India and also, more importantly, what a healthy futures and option trading approach or strategy could look like.
INTERVIEW TRANSCRIPT
Govindraj Ethiraj: Rajesh, thank you so much for joining me today. So let me pick up on some of the disclosures that you've made on derivatives on your own website, which means you're telling people that this is a risky proposition to start with, which is what SEBI is also saying, which is that nine of 10 individual traders in equity F&O or futures and options lose money. Then even those who make money, they actually lose out a lot further because of transaction costs, which they may not realize earlier, and eventually, or finally, most of them register a net trading loss of almost 50,000 rupees. So what I can see is, including from other data, a lot of people who come into this space are young. Secondly, they're losing a lot of money. And thirdly, they're also losing money, which in areas with perhaps they don't realize, for example, transaction costs. And yet, they're obviously coming and participating in this market. So let me start by asking you the flip question. First, what is wrong with the way people are approaching derivatives?
Rajesh Baheti: So two ways to look at it. Firstly, what is wrong with the way that industry, or my industry in particular, has approached derivatives. I think, you know, post covid online broking, discount broking became the big hit and volumes excluded thanks to the fact that you had two years where you pretty much did nothing from home except log into your phones or computers, and it was the easiest thing to do and to keep yourself entertained as well as productive. So one of the things I think I would blame my industry, and more particularly the discount brokerage houses, is that they onboarded a lot of people and allowed them to create every market as long as the person trading that market wanted to trade, so no kind of assessment was done as to, what is the risk appetite, what is the network status of the person who wants to enter the market and create derivatives? But rather, everybody who opened an account pretty much got a limit based on what they sent to the broker to create whatever product they wanted to so the first question, therefore, is that, should there have been a product suitability framework, which we are all talking about, and SEBI has also been talking about it. But I think our industry is at fault. Maybe we should have devised our own product suitability framework and prevented a lot of people from even entering this space if we had felt that they were probably not capable of handling the risks or understanding the risk. So in all fairness, I think we are all to blame a little bit. In my own brokerage house, we have not more than one or 2% of the clients are permitted to create the derivative segment. Most of them are refused because it's a smaller broking house. And I have a personal connect. I kind of tell the clients, no, this is a risky product, and it's not for you. But these online brokerages houses are kind of, I don't see you, you don't see me, and there's some computer bots probably accepting applications and processing these. So I think that check was missing. So to that extent, it allowed a lot of people who didn't know exactly the risks and benefits of derivatives to come in and trade. That's one point. The second thing is, obviously, this is a product with which you can control risk, and you can also enhance risk. I think the public doesn't understand that, to the extent that what is it that you can do to control risk? So that is obviously edging your portfolio, buying some protection from time to time, given some certain events along the way, and versus trying to make a quick buck by saying, you know, I'm getting an option at one box, one rupee, I can buy 10,000 of this. It's just 10,000 maximum loss. But if I win, I can win big. So it was a bit like a lottery buying a lottery ticket. And I think that kind of education is missing with the investor, and something could have been done on that front.
Govindraj Ethiraj: So Rajesh, let me ask you to illustrate that. So for example, let's say we said, Okay, if I were to buy 100 shares of Tata steel or Reliance Industries today, what could healthy derivative strategy be at this point?
Rajesh Baheti: So the most popular and healthiest derivative strategy is that you buy the underlying, let's say you bought the Tata motor stock at, say, 1000 rupees, and you say, Okay, I expect this share to go up, but I also don't think it's going to, you know, go, go to 1500 or 2000 and to hedge my risk, I will send a 1100 call or 1200 calls. So while the stock, I own, the stock, I'm able to derive some income from this stock by selling the calls. And if it were to go to 1100 or 1200 or beyond, I'm happy to take my 1015, Or 20% gain and exit the stock. So the most popular investor strategy in future and options is what we call the covered call strategy, where you own the underlying and then you sell calls on it. Those are typically out of the money, so that leaves a little bit on the table for capital appreciation. And while that capital depreciation doesn't take place, you're earning some kind of yield by selling those options. So the most favored strategy, or the most advocated strategy, for the uninitiated, is the covered call strategy on your investment.
Govindraj Ethiraj: So which means, and thus, which would have also answered my next question, is the link between the underlying stock and the activity in the derivative segment. But I'll come to that in a in a second. Do most people, or is there a proportion of people you feel do this, which is to have the underlying stock and then buy into a derivatives covered call strategy, for example.
Rajesh Baheti: So lots of people have different strategies. So the people who understand the market a bit definitely do this. The second thing is people also do the arbitrage business. So you buy in the underlying cash market, as long as the yields are at or above the bank every rates you would sell the futures. So one thing I want to reveal here that SEBI had did this study, and they have said that 60,000 crores have been lost in the derivatives market, and derivatives market is supposed to be hedging. I think there is some basic fault with this calculation. If you have calculated that 60,000 has been lost in the F&O space, have you worked out how much of it was a hedging play, because if I'm likely to hedge my portfolio and in a roaring bull market, the hedge will always, always lose money. So if I'm I'm, let's say, doing a arbitrage strategy, are you buying the underlying and selling the futures? Obviously, the market goes up 500 points, and I have booked only 10 points as my arbitrage profit, I will make 500 in my cash segment, and I will be a loser to the extent of 490 in the derivatives because I have locked my gain at 10. So when SEBI did this study, did it only take the 490 that we lost on the derivative segment as the futures and options losses, or did they look at a corresponding position of that same retail player in the cash segment to remove the edging loss.
Govindraj Ethiraj: Got it. But what's your sense? Rajesh, I mean, I do you feel that most of it is locked into underlying stock which would have appreciated and therefore the difference is lower?
Rajesh Baheti: I mean, look at the you're saying last year, the retail kind of lost 60,000 crores on derivatives. What is a market cap gain in this country? What? It's a 10 lakh crores, 15 lakh crores, how much? So? How much of that gain has been lost in the derivatives? Obviously, I'm sure at least 40 to 50% of it would have been on account of edging even all the arbitrage mutual funds. And people who do arbitrage have all lost money in the future than option space, but they've had corresponding profits in the underlying
Govindraj Ethiraj: Got it. So let me come to the last question as we run out of time. Raj, so you know, one of the instance, at least, that I could see, is the problem, that problem of younger investors, or less mature investors, who are maybe disproportionately overexposed in this space. I think when you talk about those who have underlying exposure, obviously they've understood the markets a little better. They're buying data motors and then also taking a position. When it comes to the younger lot who are clearly maybe post covid entrance in many cases, what is your sense? I mean, what should people be doing or not doing? I mean, not that they will listen to you and me, but what should be their approach to entering the market? Also, in the context of where the markets are today, we've again at record high closes for nifty and Sensex, for example.
Rajesh Baheti: So clearly, I think product suitability framework. The fact is that the industry also needs to be responsible in not allowing everybody who wants to activate the F&O segment, to activate it, to possibly have a one on one viva, understand you understand the space. What do you think is an option, what are the risks of an option seller versus what are the risks of an option buyer? What are the payoffs? Do you understand Delta? Do you understand that if you're buying a point one delta of an option, there's only a 10% chance that you will make money? So all those things, if you do some kind of an educative analysis, then yes, you will be onboarding fewer people, but you will be onboarding those people that you think are able to trade and these markets well, but as I said, to some extent, I think there has been mass onboarding. And you know what they have done? They have reduced brokerage rates to such an extent, but derivatives. Still, you're running so much brokerage that you make delivery free in those cases, so the derivatives profits for the brokerage houses are paying for the free delivery brokerage at all these sites kind of advertise. I think that is where the control was needed. Who are the kind of people who want to actually enter and trade the derivatives market rather than actually putting spokes in the seller space, because most of the retail is buying options, and that's my theory, that most of the retail wants to play with 25-30 grand that they're making, or whatever salary they're making, 25-30 grand in the option space like a lottery ticket. But if they were interviewed before they would be allowed to trade F&O, I think a lot of this could have been prevented.
Govindraj Ethiraj: So are you saying that they should be like a network cut off, or some other kind of barrier before they actually start trading?
Rajesh Baheti: So two ways to look at it is, one, there's an arbitrage today between an option buying, an option selling. Option selling requires, say, if you the lot size is 20 lakhs and the margin is 25% which requires a minimum of five lakhs. Option buying, if you're buying a one rupee option, 10,000 shares, you have to pay only 10,000 debts. So one of the solutions to kind of level this arbitrage is to say whether you are buying an option or you're selling an option, you've got to keep a minimum base capital of 5 lakhs or 10 lakhs, whatever the number you come up with, the minute you remove this arbitrage of the premium required to buy an option versus the premium or the capital required to buy an option versus the capital required to sell an option. I think all this frivolous lottery ticket buying would have stopped there and then. So the easiest solution should have been to say, it doesn't matter if you want to do F&O, you got to have a minimum balance of 5 lakhs or 10 lakhs with the broker. Whether you're buying a 10,000 rupee option or selling a 10 lakh rupee option, you got to have that minimum base capital with the broker that would have killed that arbitrage and made people do the wise trades rather than just get into this lottery kind of thing.
Govindraj Ethiraj: And quite likely that might happen, as you say, Rajesh, so thank you so much for joining me.
Rajesh Baheti: Thanks.
