Budget 2017 delivered a long-term capital gains tax googly, but not the one expected.
In December 2016, Prime Minister Narendra Modi, at an event hosted by market regulator Securities and Exchange Board of India (SEBI), suggested that market participants did not pay their fair share of taxes.
“Low or zero tax rate is given to certain types of financial income. We should consider methods for increasing it in a fair, efficient and transparent way,” he added, sparking fears that the government may withdraw the exemption on long-term capital gains tax applicable on the sale of listed equity shares on a stock exchange.
The next day, Finance Minister Arun Jaitley clarified there was no change in the offing, claiming the Prime Minister’s comments had been misunderstood.
“Low or zero tax rate is given to certain types of financial income. We should consider methods for increasing it in a fair, efficient and transparent way, he added, sparking fears that the government may withdraw the exemption on long term capital gains tax applicable on the sale of listed equity shares on a stock exchange.
But for equity investors who stood to lose an important tax break, the fear persisted. Until February 1, when Union Budget 2017 was presented and it proposed no such change or withdrawal of the long-term capital gains tax exemption.
But this story doesn’t end there, as another change in the long-term capital gains tax provision has puzzled investors and entrepreneurs.
The Finance Bill, 2017 proposes to amend the Income Tax Act, 1961, Section 10 to provide that “any income arising from the transfer of a long-term capital asset, being an equity share in a company shall not be exempted, if the transaction of acquisition, other than the acquisition notified by the Central Government in this behalf, of such equity share is entered into on or after 1 October 2004 and such transaction is not chargeable to securities transaction tax under Chapter VII of the Finance (No. 2) Act, 2004”.
In an emailed comment to BloombergQuint, he lists the types of transactions that may be impacted.
Shah writes: “For example, shares acquired pursuant to mergers/demergers which are divested on the stock exchange, listed shares acquired off-market in private deals but sold on market; preferential allotment to investors in listed entity which are subsequently sold on exchange. Hopefully, some of these may get clarified.”
While tax experts are concerned about the impact on shares acquired via restructurings and the like, Ashok Wadhwa, founder and group chief executive officer of Ambit, says the provision is anti-entrepreneur.
Not just entrepreneurs, Wadhwa worries about the impact on shares granted via employee stock option plans (ESOPs). “In a country where a large part of middle class wealth is created through ESOPs, you have now made it less attractive,” he says.
Tax advocate Rohan Shah too expresses surprise at the development.
The memorandum to the Budget explains the tax change as an effort to counter "sham transactions".
The memorandum also informs that rules will be notified to allow genuine cases to avail the tax exemption.
Wadhwa agrees that some companies may have misused the exemption but he adds, “You can’t penalise many, many right people because of a few wrong people.”
Hopefully genuine share purchases, done off-exchange, be they via a restructuring, in an IPO or through grant of ESOPs, even if sold on-exchange, will not lose the tax exemption.
But Budget 2017 did throw a long-term capital gains googly, after all. Just not the one investors expected.
(This article was originally published on Bloomberg Quint.)
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