Government Softens Blow Of Capital Gains Tax But Leaves Promoter Shares, PE And ESOPs In Doubt

The Finance Act, 2017 has introduced provisions to tax capital gains on sale of listed equity shares acquired after October 1, 2004 if the purchase of shares was not liable to Securities Transaction Tax (STT). These provisions are anti-abuse provisions aimed to tax transactions seeking to legitimise illicit wealth by camouflaging it as capital gains.

In the Memorandum to the Finance Bill, 2017, the government had acknowledged that there could be certain genuine share transactions which did not attract STT on purchase and yet should be spared this new tax provision. Pursuant to that the government has issued a draft notification to clarify which transactions shall attract the anti-abuse provision to tax capital gains. The government has invited comments from the public till April 11, 2017 after which a final notification shall be issued.

As per the draft notification, all transactions of purchase of equity shares post October 1, 2004 without payment of STT shall continue to enjoy exemption from tax on long term capital gains, except for the three items specified in the notification.

The cases where capital gains tax will be attracted are:

• Acquisition of listed equity shares of a company, on a preferential basis, where the shares of the company are not frequently traded on a recognised stock exchange in India. However, if the preferential issue is covered by the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009, the sale of such shares will continue to enjoy exemption from tax on long term capital gains.
• Purchase of listed equity shares by a transaction not entered through a recognised stock exchange.
• 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 again listed on a recognised stock exchange.

“Frequently traded shares” means shares of a company, in which the traded turnover on a recognised stock exchange during the twelve calendar months preceding the calendar month of transfer of shares, is at least ten percent of the total number of shares of such class of the company.

Thus, the draft notification specifies a list of items that will be covered under the anti-abuse provisions. It is heartening to see that the list has been kept brief and has only three items. Therefore, any transaction which is not specified in the notification shall continue to enjoy exemption from tax on long term capital gains. This will provide much-needed clarity and relief to genuine taxpayers.

But What About Gifts, Promoter Shares, Private Equity, ESOPs...?

However, further clarity would be welcome regarding the coverage of purchase of listed equity shares by a transaction not entered through a recognised stock exchange. This expression may cover certain genuine cases of transfer of shares.

1. For instance, gift of shares or acquisition of shares by way of inheritance are transactions not entered through a recognised stock exchange and may attract capital gains tax. It may be possible to argue that the notification would apply to “purchase” of shares outside the stock exchange whereas the transactions of gift and inheritance do not qualify to be purchase of shares and hence could continue to enjoy the exemption from capital gains. However, this aspect could be prone to litigation and it will be beneficial if the government clarifies its intention expressly.
2. The notification is also silent about the tax treatment of transfer of promoter shareholding.
3. It also does not clarify the position of private equity investors and strategic investors, who typically acquire shares on a private placement basis (before listing). The capital gains for such investors, though arising out of genuine transactions, could suffer tax henceforth.
4. Similar doubts could arise in case of taxability of shares acquired under Employee Stock Option Plans (ESOPs).

The intention of the government is to grant tax exemption only for genuine transactions. Hence, it would be beneficial if the intention is brought out in the notification along with specific clarifications for genuine transactions carried out outside the stock market.

Maulik Doshi is a partner at SKP Business Consulting.

The views expressed here are those of the author's and do not necessarily represent the views of BloombergQuint or its editorial team.