Indian income tax law exempts long-term capital gains arising from transfer of listed equity shares provided such transfer takes place through the stock exchange, and securities transaction tax (STT) is paid. However, the Government believes that this exemption is being misused by certain unscrupulous elements to convert unaccounted money into legal money. The law was therefore recently amended to remedy the situation, restricting this benefit only to such cases where STT is paid both at the time of purchase as well as sale.
However, since this amendment is being introduced as an anti-abuse provision, it also provided that the Government would notify certain types of acquisitions where this restrictive provision would not apply so that genuine business transactions are not impacted.
A draft notification has recently been issued by the Central Board of Direct Taxes (CBDT) attempting to list out such instances and inviting comments from stakeholders. Through this blogpost, we will discuss the efficacy and appropriateness of this draft notification.
Draft CBDT Notification
As discussed above, the recent amendment provides that the capital gains exemption shall be available only in such cases where STT is paid both at the time of purchase as well as at the sale of such listed shares, unless the shares were acquired through a mechanism which has specifically been notified to be unaffected by this provision. In other words, the import of this provision is very wide and could deny capital gains exemption to all such instances unless the notification exempts them. To protect genuine business transactions, the Government has been empowered to come up with instances where the exemption will not be denied. Hence, the nature of transactions to be specified by the notification shall be very important to determine the taxability of capital gains.
The draft notification clarifies that all transactions involving acquisition of equity shares will continue to enjoy the benefit except for specific types of acquisitions provided in the draft notification. Thus, while the amendment intended to cover all types of transactions in an inclusive manner, the draft notification attempts to provide an exhaustive list of instances where the exemption shall be denied.
The draft notification provides that exemption from capital gains would be denied in the following cases:
A. In case shares are issued through a preferential allotment to a specific investor or group of investors and such shares are not frequently traded on the stock exchange except those allotted through SEBI Regulations dealing with issue of capital [i.e. Chapter VII of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR)].
While the manner in which this provision has been drafted in the notification can lead to multiple interpretations, the most appropriate seems to be:
- It does not intend to cover shares that are regularly traded on the stock exchange at all.
- It does not intend to cover all preferential issues made by the companies whose shares are not frequently traded in the stock exchanges. The types of preferential issues that are proposed to be covered within the scope of this provision does not include offer of specified securities made through a public issue, rights issue, bonus issue, employee stock option scheme, employee stock purchase scheme or qualified institutions placement, preferential issue of shares pursuant to conversion of loans or options attached to convertible debt instruments, issue of shares pursuant to a scheme, an issue of sweat equity shares and depository receipts issued in a country outside India, etc. It may be assumed that these specific forms of acquisitions have deliberately been excluded from the applicability of this anti abuse provision.
B. Purchase of listed equity shares of a company, otherwise than through a recognised stock exchange.
It appears that while the first condition deals with instances of primary acquisition, which would not be entitled to the capital gains exemption, the second condition intends to provide instances of secondary acquisition that will get impacted. The fact that the requirement deals with secondary acquisitions is also evident because it uses the term “purchase” because only an existing security can be purchased. However, it is not free from doubt since the term “purchase” has not been defined under the Act and thus, it would be appropriate to revise the language in the final notification to clarify that this condition intends to cover acquisition of already existing shares of listed companies that are not frequently traded on a recognised stock exchange.
If the language is not revised, a number of genuine transactions could get covered within its ambit:
- Purchase of equity shares by a strategic investor outside the stock exchange;
- Acquisition of shares outside the recognised stock exchange, through an open offer, under the SEBI Regulations;
- Acquisitions of shares by employees under an employee stock option scheme through an employee welfare trust, rights issues, acquisition by non-residents outside the stock exchange even though the acquisition is in accordance with extant FDI regulations, etc.
- Other off-market transfers by way of gift, family settlement, inheritance, intra-group restructurings within the promoter group, etc.
C. Acquisition of equity shares of a company during its delisting period.
While certain parties may have adopted this route to convert their unaccounted money into legal money in the past, a blanket ban could impact genuine transactions since companies could be delisted for some time and subsequently get re-listed depending on business exigencies and not with an intention to evade taxes. Thus, adequate safeguards need to be built into these provisions to address this issue.
It must be noted that while the explanatory memorandum to the Finance Bill had very specifically clarified that this is an anti-evasion provision and the press release reiterated the same understanding, the draft notification seems to have missed this perspective.
It is imperative that the Government modifies the notification in a way that the above mentioned concerns are addressed and the tax authorities have very limited discretion in applying the provision. At the same time, tax authorities should have the power, after due verification, to not apply this anti-abuse provision in respect of legitimate and genuine business transactions.
* The author was assisted by Mehreen Zafar, Associate