This article summarises the amendment brought in Section 10(38) of the Income Tax Act, 1961, the exemptions provided under the section through notification issued by the central government and discusses few situations where exemption may not be available.
Prior to the Finance Act, 2017, section 10(38) of the Income Tax Act, 1961 (ITA) provided exemption on any income arising on sale of listed equity shares held for a period of more than 12 months, if Securities Transaction Tax (STT) was paid on such sale.
The memorandum to the Finance Act, 2017 stated that the exemption provided under section 10(38) of the ITA was misused for declaring unaccounted income as exempt from long term capital gains by entering into sham transactions. To re-align the benefit granted under this section with its intent, the Finance Act, 2017 has amended section 10(38) of the ITA, to provide that exemption from income arising on transfer of long-term equity shares acquired on or after 1 October, 2004, shall be available only if STT is paid when acquiring shares. However, to protect such exemption for genuine cases (IPO, FPO, bonus, rights issue) in which STT could not have been paid, central government would notify certain transactions.
The CBDT had issued a press release on 3 April, 2017, along with a draft notification to be issued under section 10(38) of the ITA. The draft notification contained a list of transactions for which the exemption under the section would not be available.
On 5 June, 2017, the central government issued the final notification in this regard. While the final notification is similar to the draft notification in terms of prescribing a list of transactions, relaxation has been provided for some transactions of acquisition.
The acquisitions made on or after 1 October, 2004, without payment of STT and that shall not be entitled to exemption under section 10(38) of the ITA are reproduced as follows:
a. Where acquisition of existing listed equity share in a company whose equity shares are not frequently traded in a recognised stock exchange of India is made through a preferential issue.
b. Where transaction for acquisition of existing listed equity shares in a company is not entered through a recognised stock exchange of India.
c. The 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 immediately preceding the date on which the company is again 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 (15 of 1992) and the rules made thereunder.
To exclude genuine transactions of acquisitions of listed equity shares, made without payment of STT, the CBDT excluded the following transactions, which would not be subject to the above rigour.
| Exclusions to clause (a) | Exclusions to clause (b) |
| Acquisition approved by the Supreme Court, High Court, National Company Law Tribunal, Securities and Exchange Board of India or Reserve Bank of India in this behalf. | Acquisition through an issue of shares by a company other than the issue referred to in clause (a). |
| Acquisition by any non-resident in accordance with foreign direct investment guidelines issued by the Government of India. | Acquisition by scheduled banks, reconstruction or securitisation companies or public financial institutions during their ordinary course of business. |
| Acquisition by an investment fund being a Category I or a Category II Alternate Investment Fund or a venture capital fund referred to in section 10(23FB) of the Act or a Qualified Institutional Buyer. | Acquisition which has been approved by the Supreme Court, High Courts, National Company Law Tribunal, Securities and Exchange Board of India or Reserve Bank of India in this behalf. |
| Acquisition through preferential issue to which the provisions of chapter VII of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 do not apply. | Acquisition under employee stock option scheme or employee stock purchase scheme framed under the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. |
| Acquisition by any non-resident in accordance with foreign direct investment guidelines of the Government of India. | |
| Acquisition of shares of company made under Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulation, 2011. | |
| Acquisition from the government | |
| Acquisition by an investment fund being a Category I or a Category II Alternate Investment Fund or a venture capital fund referred to in section 10(23FB) of the Act or a Qualified Institutional Buyer; | |
| Acquisition by mode of transfer referred to in sections 47 (e.g., transfer of capital asset under a gift, transfer of capital asset to an irrevocable trust, transfer of capital asset between holding company and its subsidiary, transfer pursuant to amalgamation, demerger, etc.) or 50B (slump sale) of the Act, if the previous owner of such shares has not acquired them by any mode referred to in clause (a) or clause (b) or clause (c) [other than the transactions referred to in the proviso to clause (a) or clause (b)]. |
This Notification is with effect from Financial Year 2017-18. Hence, any transactions (between 1 April, 2017 and 5 June, 2017) that are covered under the Notification, will be subject to tax (in the year of sale of shares).
The 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 may still pose challenges for transactions in highly valued companies that are not frequently traded.
The final notification has addressed most of the genuine transactions not covered in the draft notification. However, it will be helpful to provide clarity for some genuine transactions, such as in case of any distribution of existing listed equity shares by a company to its shareholders on liquidation, transfer of shares between relatives for consideration or strategic acquisitions by private equity investors from promoters of existing listed companies.
The Notification has assailed many do’s and don’ts and it is clear that the government wants to restrain any non-genuine transactions with its amendment.
Authors: Rekha Bagry, Partner, M&A Tax PwC India and Manjit Bhimajiani, Associate Director, M&A Tax PwC India
Views expressed are personal to the author and the article contains inputs from Pradeep Sethia, Assistant Manager, M&A Tax, PwC India and Nihal Rajendran, Associate, M&A Tax, PwC India
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For availing exemption u/s 10(38) of income tax STT ought to be paid at the time of acquisition .But what is the tax implication if it is paid at the time of exiting . Will it qualify for the exemption ? Like in the case of mutual fund