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The benchmark Shanghai Composite Index has nosedived 7.08 percent to 3,717 points by 10:19 am before recovering gradually.

Investors were spooked by speculation on the collection of capital gains tax and on the abolition of tax on interest accrued from deposits. Taxation officials have rejected the rumor, but that did not seem to reassure the investors.

The Ministry of Finance denied an increase in stamp tax on trading on May 22, but then announced seven days later the tripling of the rate to 0.3 percent from 0.1 percent, triggering a 6.5 percent drop in the Shanghai Composite Index.

China will eventually start to levy capital gains tax on stock trading, said Hu Bing, an official with the China Securities Regulatory Commission Thursday in New York, according to earlier reports.

The lack of the duty lead to a widening of the gap between the rich and the poor, Hu noted. "However, phasing in capital gains tax is a long-term process as it is a major issue that depends on the development of the market."