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In the 2017 Budget, an amendment was made to the provisions relating to the exemption for long-term capital gains on sale of listed equity shares on a recognised stock exchange. The amendment provided that the exemption would not apply to equity shares acquired from 1 October 2004 onwards, where no securities transaction tax (STT) was paid on the acquisition.
The government has been given the power to exclude certain types of transactions from the exclusion, that is, to notify certain types of transactions that would continue to get the benefit of the exemption, even though STT was not paid on such transactions on or after 1 October 2004. The final notification of such transactions was finally issued in the first week of June 2017. The notification is worded in a negative manner. All transactions qualify to continue to get the exemption, except three types of transactions. There are exceptions even to these three types of transactions—these exceptions will also continue to enjoy exemption. Which are these three types of transactions, and what are the exclusions?
The first type of transaction that will not qualify for the exemption is the acquisition of existing listed shares through a preferential issue, where the shares of the company are not frequently traded. Frequent trading would be judged by whether 10% or more of the total number of shares of the company have been traded during the earlier 12-month period. The issue of shares should be one considered as a preferential issue under the regulations by the Securities and Exchange Board of India (Sebi). There are certain exclusions in the Sebi Regulations (such as conversion of debt); these would continue to get the benefit of exemption.
An exception to the first type of transaction are cases where the acquisition has been approved by the Supreme Court, High Court, National Company Law Tribunal, Sebi or the Reserve Bank of India. These cases would be situations of mergers, demergers, restructuring of capital, and others. Besides investments by non-residents under the foreign direct investment route, or by alternative investment funds, venture capital funds or qualified institutional buyers would also be excluded. All these would continue to qualify for the exemption.
The second type of transactions that will not qualify for the exemption are transactions of acquisition of an existing listed equity share not through a stock exchange. In this case, the exceptions which will continue to get the exemption, besides the exceptions to the first type of transaction, include allotment of shares under an employee stock option plan (Esop) and the transfers that are exempt from capital gains. Transfers exempt from capital gains would include shares received by way of inheritance, as gifts, on partition of a Hindu Undivided Family (HUF), on settlement on a Trust, on conversion of preference shares or debentures, or others.
The third type of transactions that will not get the benefit of exemption are the acquisition of shares of a company during the period in which it is delisted, before re-listing.
Purchase of an infrequently traded share on a stock exchange would not be affected by the amendment, and would continue to get the exemption on sale. It is only if the shares are allotted by a company under a preferential issue, that there would be denial of exemption on sale. Transactions such as conversion of convertible securities into shares will still qualify for the exemption, as will receipt of shares under Esop, inheritances, gifts, partition of HUF, and others. Besides, shares of a company that are acquired when they are not listed, but which get listed later, would also get the benefit of the exemption on sale.
There are, however, still some genuine transactions that may get impacted. While settlement of shares on a Trust would qualify as an acquisition eligible for exemption on sale, there is no clarity about the position of the beneficiary of a Trust receiving shares on distribution by the Trust. Similarly, if you happen to purchase listed shares of a company from friends or relatives, to accommodate their immediate need for funds (often this may happen when the shares are not dematerialised), you may find yourself having to pay capital gains tax on ultimate sale of the shares.
By and large, the notification addresses most of the major concerns that taxpayers had when the budget amendments were brought in, and excludes most genuine transactions from the ambit of the amendment. There are, of course, exceptional situations that may still get impacted. It is admittedly difficult for any legislation to deal with all possible permutations and combinations, and therefore the notification is fair and reasonable.
The only problem is the language of the section and the notification, which makes it difficult for even a professional to comprehend. The tax exemption has an exclusion, which has notified exceptions. The notified exceptions have exclusions, which again have exceptions. This could be a real test for law students to test their comprehension skills.
Gautam Nayak is a chartered accountant.