Hiten Kotak – M&A Tax Leader (Left) , PwC India, & Rekha Bagry (Right) – M&A Tax Partner, PwC India
The Finance Bill, 2017 had proposed an amendment to section 10(38) of the Income Tax Act, 1961 (ITA), which applies long-term capital gains taxation in the context of sale of listed company shares. It was proposed that exemption for income arising on transfer of long-term equity shares acquired on or after 1 October, 2004, shall be available only if the acquisition of shares is chargeable to STT.
The memorandum to Finance Bill, 2017, explained that the exemption provided in section 10(38) of ITA was misutilised to declare unaccounted income as exempt long-term capital gains, by entering into sham transactions. The central government was to notify transactions to which this amendment would not apply.
This resulted in apprehension that genuine transactions would also be caught unless the central government covered an entire list of genuine transactions.
The Finance Bill, 2017 has been approved by the Parliament and received the assent of the President. Post that the CBDT has issued a draft notification (Notification) on 3 April, 2017 and provided that the amendment would not apply to any transaction except the following:
a) Acquisition of listed equity shares in a company, whose equity shares are not frequently traded in a recognised stock exchange of India, is made through a preferential issue other than those preferential issues to which the provisions of chapter VII of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR) do not apply.
b) Transactions for purchase of listed equity share in a company are not entered through a recognised stock exchange.
c) Acquisition of equity shares of a company during the period beginning from the date on which the company is delisted from a recognised stock exchange and ending on the date on which the company is re-listed on a recognised stock exchange, in accordance with the Securities Contracts (Regulation) Act, 1956, read with Securities and Exchange Board of India Act, 1992 and any rules made thereunder.
Thus, the amendment applies only to these transactions. This article discusses a few aspects of the same.
Preferential Issue regulations of ICDR do not apply to issue of equity shares pursuant to a scheme approved by the High Court under sections 391 to 394 of the Companies Act, 1956 or a Tribunal under sections 230 to 234 of the Companies Act, 2013.
However, prior to the Notification, SEBI amended the Preferential Issue regulation to say that the pricing guidelines of the Preferential Issue would apply to certain specific situations of merger and de-merger (allotment of shares to a select group of shareholders or shareholders of unlisted companies). The exemption under section 10(38) of ITA would be available to shares issued pursuant to merger or de-merger (as the Preferential Issue regulations do not apply) but is a different implication likely for specific cases of merger/ de-merger to which the pricing guidelines of Preferential Issue regulations apply?
The draft notification defines “frequently traded shares” as shares of a company, in which the traded turnover on a recognised stock exchange during 12 calendar months preceding the calendar month in which the transfer is made, is at least 10% of the total number of shares of such class of company. This definition is the same as mentioned in the SEBI Takeover code 2011. This may pose challenges for highly valued companies that are not frequently traded.
Preferential issue, as defined in the ICDR, does not include an offer of specified securities made through a public issue, rights issue, bonus issue, ESOP scheme, employee stock purchase scheme or qualified institutions placement or an issue of sweat equity shares or depository receipts issued in a country outside India or foreign securities. Hence, it could be said that IPOs, FPOs, rights issue, bonus, ESOP, etc., would not be covered by the rigor of the amendment.
ESOPs are not covered as part of preferential issue; however, if employees purchase the shares from the ESOP Trust, are they out of the rigor of the amendment? A clarification would be most helpful and avoid unnecessary confusion.
Point (b) of the Notification refers to purchase of shares, and hence, transactions such as shares issued pursuant to merger/ demergers, gift, IPOs, FPOs, rights issue, bonus and ESOP should not be covered by the amendment.
It is clear that the objective is to catch abusive transactions. Hence, genuine transactions, which are regulated, should not be denied benefits, for example, purchases that trigger open offers and strategic purchases that happen off market. Considering the objective, this would be a fair ask.
The government has done a fantastic job by providing a negative list instead of providing a laundry list of exempt scenarios. However, clarity on certain situations discussed here, in the final notification, would be a welcome move to alleviate the fear among genuine stakeholders. The CBDT has sought comments from the public by 11 April, 2017.
(Views expressed are personal to author and the article includes inputs from Manjit Bhimajiani, Associate Director, M&A Tax, PwC India and Nihal Rajendhran, Associate, M&A Tax, PwC India)