How are gains taxed when you buy Unlisted Shares and Sell after Listing?

A common question that comes up is about the tax treatment when someone buys shares of an unlisted company and later sells them after the company gets listed on a stock exchange. In these situations, STT (Securities Transaction Tax) is obviously not paid when buying the shares because the company is not listed at that time. But STT is paid when selling the shares after listing. The main confusion is whether the profit from such sales should be treated as long-term capital gains under section 112A of the Income Tax Act, 1961, or as short-term capital gains, since STT was not paid at the time of buying, even if the holding period is more than 12 months.

Section 2(42A) of the Act says that if listed securities are held for more than 12 months, they are considered long-term capital assets. What is important here is that this section does not require the shares to be listed when you buy them—it only checks whether they are listed when you sell them. The holding period is counted from the date you originally bought the shares to the date you sell them, and if the company gets listed during this period, it does not restart the clock. So if you bought shares when the company was unlisted and at the time of sale after listing, more than 12 months have passed since purchase, the entire holding period counts, and your gains would be long-term capital gains.

To illustrate this, consider the following scenarios:

Some people wonder if not paying STT at the time of purchase changes this treatment. It seems like it does not. Section 112A, which deals with tax on long-term capital gains from equity shares, does require STT payment, but the government has issued notifications under sub-section (4) of this section that relax the STT requirement at the time of acquisition in certain cases. Through Notification No. SO 1789(E) [No. 43/2017 (F.No. 370142/09/2017-TPL)], dated June 5, 2017, the Central Government has listed transactions where the condition of paying STT at acquisition does not apply. This notification covers cases where transactions happened after October 1, 2004, but were not subject to STT because of their nature. When shares are bought while the company is unlisted, STT simply does not apply at that stage, and such purchases do not fall in the excluded categories mentioned in the notification. As long as STT is paid when selling after listing, the requirements for applying section 112A seem to be met.

This understanding is supported by the Income Tax Appellate Tribunal. In DCIT v. Business Excellence Trust (ITA No. 2879/Mum/2023), the Mumbai Bench decided that when shares were acquired without paying STT because they were unlisted and were later sold after listing with STT payment, the fact that STT was not paid at acquisition should not be a reason to deny long-term capital gains benefits. Though the decision was rendered in the context of section 10(38), the logic seems to apply equally to section 112A since both provisions work on a similar STT-based framework.

Based on this understanding, when equity shares are bought while the company is unlisted and sold after the company gets listed, the holding period should be calculated from the original purchase date. If this period is more than twelve months, the gains would be treated as long-term capital gains. The fact that STT was not paid when the shares were bought should not affect this classification, as long as STT is paid at the time of sale. Such long-term capital gains would therefore be taxable under section 112A of the Income Tax Act at the prescribed rate.