Our G-Sec market is primarily bankoriented with only a handful of corporate investors. The secondary market is based on over-the-counter transactions
Tax Deducted at Source (TDS) was introduced to collect taxes at source from where a person's income is generated. This is a tool that facilitates the government to minimise tax-evasion as the tax is deducted from the income at the time it is yielded.
Government securities (G-Sec) are the main pillars of the fixed-income securities markets in both developed and developing countries. They provide a benchmark yield curve which can help to establish the overall credit curve for the market.
The government bonds are typically considered a risk-free financial asset. They serve as the primary source of financing for the national budget deficit and infrastructure projects taken by the state.
At the microeconomic level, the development of a domestic fixed-income securities market can increase the overall financial stability of a country.
Besides, the development of a fully functional fixed-income securities market can help change the financial system from a primarily bank-oriented to a multi-layered system, where capital markets can complement bank financing.
Our G-Sec market is primarily bank-oriented with only a handful of corporate investors. The secondary market is based on over-the-counter transactions.
More specifically, provident, gratuity, trust and mutual funds all together held less than five percent of BDT 1,993 billion outstanding dues at the end of June 2019, as per Bangladesh Bank's report.
The investment corporations and retails investors held no more than 0.5 percent of the outstanding amounts. There were no foreign investors at all.
The government has expressed its intent to make the fixed-income market vibrant. Hence, the Bangladesh Bank, Bangladesh Securities & Exchange Commission (BSEC) and DSE are working together to include G-Sec into the trading platform of DSE, in a bid to attract retail investors into the bond market.
On the other hand, the government also proposed a five percent source tax on coupon/interest payment of the securities from the next financial year.
The proposed TDS has two issues: (i) tax complexity, and (ii) possibility of low market particiption, which is going to have a serious repercussions on the government's plan to make G-Sec market vibrant.
First, in practice, we normally settle bond trading at a dirty price which includes accrued interest with the principal amount.
Under the proposed TDS, the tax impacts will be only on the final holder who receives the coupon, meaning that whoever holds before the coupon payment may not pay tax on the accrued interest income.
On one hand, the interim holders may reap the gains without having any tax liability since the interest is paid half-yearly. On the other hand, even though the intermediate holders has to pay tax, the proportion and basis are not clear. This situation can create a tax calculation complexity for retails investors.
Another confusion is about who will be held responsible for paying interim interest income, and who will be the deductor and give TDS certificate to interim holders of government securities.
This complexity will drive away ordinary investors. Hence, the TDS introduction is going to be adverse for bond market development which has been a demand for many years.
Secondly, provident and gratuity funds, mutual and other funds will have an additional burden on the investors' money. The income of mutual funds is exempted from tax under the SROSRO No 333-Ain /IT / 2011 dated November 10, 2011, and under section 44(4) clause(b) of Income Tax Ordinance,1984. Other funds and trusts are also exempted from paying tax under section 44(1) of ITO 1984.
The source tax will compel the mutual funds to shy away from investing in the G-Sec market. Moreover, advanced securities markets have mutual funds focusing wholly on debt securities, which are absent in the current capital market in Bangladesh.
The BSEC chairman recently expressed his interest in allowing different types of mutual funds, including ones concentrating on the bond market. The changed scenario may close the door for such type of funds in the market, which will only deprive the investors, considering the current miserable state of our capital market.
These issues are likely to reduce demand for the G-Sec among retail investors, including mutual funds. If the demand falls in the current situation with growing need of domestic borrowing, the government's borrowing costs may shoot up and they will be borrowing at a higher cost, at the expense of public money. Additionally, during volatile economic periods and the bearish stock market, the investors find some haven in the bond market. However, this will be lost if they are to pay additional tax upfront.
If we focus on the trends of other government borrowing sources, we see that the national savings certificates (NSCs) is showing a declining trend, with borrowing interest ranging from 11.04 to 11.76 percent, which is 200+ basis point higher than G-Sec market borrowing. The declining trending may continue due to ongoing economic fallout, pandemic situations, individual investment threshold, 10 percent source tax, and TIN requirements.
In terms of external borrowing, the government already set a net target of Tk760 billion for FY2020-21, which is an all-time high in the history of Bangladesh. However, the trends in foreign loans suggest that the government may not achieve its target and may need to rely more on G-Sec market borrowing for financing budget deficit.
India's income from government bonds is tax-free except for GOI Savings Bond that also got tax relief up to interest income of Rs 10,000 (Tk12,280) from savings. In the case of G-Secs, investors pay the necessary taxes on the interest income, if applicable.
The same laws and tax measures have been in practice in most countries of the world. So, Bangladesh government should have a parallel practice. If not, it is going to have negative effects on budget deficit financing and the government's fiscal plan.
Considering all facts with the current market situation, TDS imposition on G-Sec is not appropriate under the current conditions. Hence, we would like to recommend that the fiscal policymakers revisit their stand and remove TDS on G-Sec.
At the same time, they should also promote the market participants so that G-Sec be more vibrant, and the government can borrow at a much lower cost.
Nupur Chandra Dhar is a fellow member of ACCA and head of compliance in an asset management company. Her email address is: Email: firstname.lastname@example.org
Mohammad Enamul Hoque, DBA is head of research in an asset management company. His email address is: email@example.com