Mumbai: A proposal in Union Budget 2017 to deny long-term capital gains (LTCG) tax exemption on sale of listed securities if securities transaction tax (STT) was not paid at the time of acquiring them could upset the tax planning of companies who use this route to save tax.
Under current norms, any capital gains from shares held for more than a year are fully tax-exempt if STT of 0.1% is paid at the time of selling them.
Currently, STT is not paid when shares are acquired in off-market transactions such as gifting, issuing employee stock options and selling shares to private equity firms.
Following the change, holders of such shares will not be able to claim LTCG benefit, since STT wasn’t paid on their acquisition.
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Though the new clause introduced in the budget exempts the acquisition of shares in initial public offers (IPOs), follow-on public offers (FPOs), rights issues and bonus issues, there is a lack of clarity on preferential allotment and qualified institutional placements.
Speaking at a Mint-CNBC TV18 event, revenue secretary Hasmukh Adhia said the provision was mainly formulated as an anti-abuse provision. “Many penny stock companies were coming up where investors were investing money and inflating the value of stock and then exiting. This is a provision targeted at this kind of transactions. Genuine transactions will not be covered under this provision. The law provides for exemptions and we will notify these to protect genuine transactions," he said.
“In case of preferential allotment and qualified institutional buyer (QIB) placement, STT is not paid during the time of allotment or acquisition of shares as they are transferred outside stock exchange platform," explained a Securities and Exchange Board of India (Sebi) official who did not want to be identified.
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“There is a need for an exhaustive list of exemptions—it could impact promoters of companies as they acquired shares of a company (before it listed), share allotment during mergers and ESOPs. In my view, these should be exempt while ensuring that preferential allotment and similar allotments are taxed," said Riaz Thingna, director at Grant Thornton Advisory Pvt. Ltd.
Additionally, many companies for effective tax planning used to issue shares of listed companies to relatives, partnership firms and trusts as gifts.
“These shares were issued to relatives in an off-market transaction and later sold. Considering that there is an LTCG exemption, they were able to get the tax benefit," said Rahul Garg, partner, PricewaterhouseCoopers Pvt. Ltd.
“Secondly, when a huge chunk of shares are sold, then the companies can be levied minimum alternate tax (MAT) at the effective rate of 20%; to avoid this, companies used to issue shares as gifts to partnership and limited liability partnership firms. In the third such scenario, these shares were allotted to trusts and similar structures to avoid tax payments," he added.
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While some tax experts are waiting for the list of exemptions, others say that this was not needed. “Any exemption list may not be able to capture all genuine share transfers that are done for corporate structuring. The intent was to tax sham transactions for which the government already has a tool in General Anti-Tax Avoidance Rule," said Girish Vanvari, national leader-tax, KPMG India.
“It has been noticed that the exemption provided under Section 10(38) is being misused by certain persons for declaring their unaccounted income as exempt long-term capital gains by entering into sham transactions," said the finance bill, clarifying the government intends to prevent tax evasion when shares are allotted.
Remya Nair in New Delhi contributed to this story.