Business Opinion / John McManus: As an exercise in muscle flexing it was pretty impressive. Just over two weeks ago, on St Patrick's Day, the Revenue Commissioners issued an edict that stockbrokers are going to have to start paying stamp duty on shares they buy to underpin contracts for difference (CDF).

Within days the member firms of the Irish Stock Exchange met at the Stock Exchange and decided to talk to the Minster for Finance, Brian Cowen, about it.

Five days later the Minister for Finance announced that he will review the whole issue of stamp duty on shares in order to to ensure that "the market in Irish equities would continue to be a liquid market, conducive to capital acquisition by Irish firms".

The Department will now "consult with the Revenue and with market participants with a view to an appropriate announcement being made in Budget 2007".

In the meantime shares bought in connection with CFD's remain exempt from stamp duty and the brokers go on their merry and rather lucrative way. (Although it's worth noting that the Revenue Commissioners have only withdrawn their compliance notice and not their view. This creates a degree of legal uncertainty as to what the current situation is, although the intent seems clear enough.)

The exact nature of the arm twisting administered to the Department of Finance is not clear. But a certain amount of the brokers' arguments were rehearsed in public.

The nuts and bolts of their case was that if the tax treatment of this particular aspect of their business was changed, investors would flee the Dublin market and the taxpayer would be the loser in the end as the annual capital gains tax haul from share sales dwindled. Share sales account for around 40 per cent of the annual capital gains tax take of around €1.5 billion.

The more apocalyptic version of the brokers' argument had stockbroking firms going out of business as they were forced to cough up millions in back taxes, plus interest and penalties on the shares they bought.

The Minster's decision to bow to such scaremongering is surprising on a number of fronts. Not least that it seems to set a precedent that if a lot of people are making a lot of money doing something that the Revenue considers to be in breach of tax law they should be allowed continue doing it, if the economic consequences are in any way serious.

Its a classic lesser of two evils argument, similar to the now discredited mantra that the banking industry here would collapse if the Revenue Commissioners went after non-resident and offshore accounts.

No doubt the Department was guided by pragmatism also, as it could take it for granted that the brokers would not take the imposition of the tax lying down. When you throw in the fact that a review of the stamp duty on share transactions is not a bad idea, then the Minister's actions seem reasonable, if very favourable, to the broking houses.

The whole issue of taxing CFDs raises a number of interesting points. From one point of view, by leaving the status quo intact the Minister is actually favouring short-term speculative investors over long-term investors such as pensions funds. These funds typically buy and hold shares for significant lengths of time and in the process incur stamp duty.

Buying a CFD is in many ways the the polar opposite of long-term investing. Firstly you are not even buying a share, but merely the entitlement to the gains (and the losses) on the share in a particular period .

Secondly, because the purchaser of a CFD only puts down a fraction of the price of the underlying share - normally 10 per cent - the purchase in inherently leveraged which only serves to increase its appeal to short-term investors.

The idea that the Minister for Finance should actually condone favourable tax treatment of this type of investment over plain vanilla share buying is hard to defend.

And the fact that between 20 and 50 per cent of the trades done in Dublin are done via CFDs should actually set the alarm bells ringing in Merrion Street. The Department should be asking themselves what will happen to all these leveraged investors when the inevitable down turn in the market comes.

The answer is that a lot of them will get very badly burned and - such is the nature of these things - the ones that get burnt the worst will be the small investors.

The easiest and most equitable solution would be the abolition of stamp duty on all types of share purchases which would cost the exchequer some €320 million a year or more.

Its a lot of money just to keep the brokers happy.

jmcmanus@irish-times.ie