Some tax experts, however, point out that there are taxation issues on which clarity from the tax department could make a huge difference, especially for the foreign institutional investors.

The Central Board of Direct Taxes (CBDT) wants to clarify or spell out the tax implications of short-selling and securities lending and borrowing by institutional investors only after a full-fledged securities lending and borrowing (SLB) scheme is put in place by the stock exchanges.

The Securities and Exchange Board of India had in December last year said that the SLB scheme would be within the overall framework of Securities Lending Scheme 1997.

Although institutional short-selling was to start on February 1, 2008, it has been delayed reportedly on account of want of clarification from the CBDT on certain taxation aspects.

When contacted, official sources in the revenue department said that the CBDT could clarify or spell out the tax implications only after the SLB is put in place.

How can one decide on the tax implications unless one knows for sure how the borrowing and lending scheme is proposed to be played out. Taxation is only incidental and subsequent issue. That cannot be a reason why an independent regulatory body should hold the implementation of institutional short selling, sources said.

Some tax experts, however, point out that there are taxation issues on which clarity from the tax department could make a huge difference especially for the foreign institutional investors.

FIIs would like clarity on whether short-selling and the profits made from them would be treated as trading profits or capital gains. It would be big issue for entities, say from Hong Kong, which do not enjoy treaty protection. Any decision to treat them as trading profits would imply a tax rate of 42 per cent. Moreover, there is also the risk that their entire income (not only from short selling) would be treated as trading profits, Mr Hiresh Wadhwani, Partner (Financial Services), Ernst & Young, told Business Line.

Initially, contracts with a tenure of seven trading days are proposed to be introduced. Apart from the characterisation of income (trading profits or capital gains), sources said that there are taxation issues such as levy of securities transaction tax on the lending and borrowing side of the transactions. There is also an issue whether short selling would be considered as speculative transactions by the tax department.

Whether STT is applicable on borrowing of securities or not should be spelt out, a tax expert said, although many felt that STT will not apply for lending and borrowing of securities even if these are done through the stock exchange platforms.