The Finance Act of 2017 had amended Section 10(38) of the Income Tax Act, 1961 ("IT Act") to the effect that long term capital gains ("LTCG") from transfer of equity shares of companies listed on stock exchanges, would be exempt from tax only if securities transaction tax ("STT") was paid at the time of acquisition of such shares ("Amendment"). Prior to this change, any LTCG arising from sale of equity shares was exempt from tax if STT was paid at the time of such sale. Thus pursuant to the Amendment, exemption from LTCG tax would be limited to cases where STT was paid in both legs of purchase and sale of equity shares.
The Amendment is part of a string of Governmental actions seeking to curb unaccounted income and black money. The memorandum to the Finance Bill mentioned that the exemption provided under Section 10(38) was being misused by certain persons for declaring their unaccounted income as LTCG by entering into sham transactions; and hence, the above step was brought in as a measure to prevent such practices. The memorandum had also added that the Government would notify certain exemptions to the provision so as to protect genuine cases where the STT could not have been paid at the time of acquisition of the shares being sold, such as acquisition of shares in an IPO or FPO, bonus or rights issue by a listed company, acquisition by non-residents in accordance with the FDI policy, etc.
The proposed change, however, caused considerable consternation amongst promoters and investors alike, as there was hardly any guidance on whether all genuine transactions, for instance acquisitions prior to the listing of a company, would be protected.
The Government recently put up a draft notification concerning the sale transactions that would be exempted from the rigors of the Amendment. The notification provides for a negative list of three instances wherein the tax exemption under Section 10(38) would not be applicable if no STT was paid at the time of acquisition of such shares being sold. In all other cases, the seller (subject to the payment of STT during sale) would not be burdened with LTCG tax even if no STT was paid when such seller acquired the shares being sold.
The three kinds of transactions notified by the Government are:
- acquisition by way of preferential issue of listed equity shares in a company whose equity shares are not frequently traded on a recognized stock exchange, except in cases where the regulations relating to preferential issue under the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 are not applicable to such issue;
- purchase of listed equity shares in a company which is not entered through a recognized stock exchange; and
- acquisition of equity shares of a company during the period between the delisting of such company and its relisting on a recognized stock exchange.
The Government has taken the right approach by introducing a negative list of acquisitions which would not offer LTCG tax exemption to the purchaser when subsequently selling those shares. The primary fear amongst the stakeholders pursuant to the Amendment was whether the Government would be able to capture and exempt all instances of genuine share transfers, and the approach of having a limited negative list is a step in the right direction. It is now abundantly clear that any acquisition of shares of a company prior to its listing would not be affected by the Amendment.
However, the notified list of acquisitions has the potential to capture even certain genuine transactions within its ambit.
For instance, second and third items in the list could be read to include issuance of ESOPs to employees by a listed company within their scope. This seems to be an oversight on part of the Government as the Revenue Secretary soon after the proposal at the Union Budget for Amendment had clarified that ESOPs would not be adversely affected by it.
Another issue with the broad language of the second item is that it captures all off-market purchases of listed company shares. It is commonplace for strategic buyouts and private equity acquisitions in listed companies to be structured through negotiated off-market deals. It is not clear at this point if the Government intentionally took away the exemption for all off-market acquisitions. If this indeed is the case, it could adversely impact the appetite amongst private equity players and strategic investors in doing secondary transactions in listed companies.
Also, since it might be difficult for the Government to list down each and every exceptions to the negative list and thereby ensure that no genuine transaction is affected by the Amendment, it would be worthwhile if the seller is given a chance to showcase the genuineness of a transaction and claim the LTCG tax exemption even if the concerned sale falls within the negative list of transactions.
The Government has sought comments from the stakeholders on the draft notification, and it is hoped that the final notification would address the above issues.
The views expressed in this article are of the author and not the firm.
