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.
The next day Finance Minister Arun Jaitley clarified there was no change in the offing, claiming the Prime Minister’s comments had been misunderstood.
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”.
EY India Executive Director Amrish Shah interprets that to mean “long-term capital gains exemption is available only if Securities Transaction Tax (STT) has been paid both at time of acquisition and divestment”.
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 the Finance Minister’s speech sounded the Budget to be non-adversarial on taxation of listed company transactions, a look at the fine-print of the Finance Bill may not see this in the same perspective. One such matter is the amendment proposed in Section 10(38) of the Income Tax Act. It would be the duty of the government to ensure that such an amendment doesn’t cast nuisance value for genuine restructuring transactions meant for facilitating business improvement and growth.Ravi Mehta, Partner, Grant Thornton India
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.
I recapitalised Ambit it in 2007. And it’s interesting isn’t it, if I list Ambit, everybody else who buys and sells Ambit stock will get the benefit of the long-term capital gains tax exemption but the guy who worked hard, who built it all up, does not get the benefit.Ashok Wadhwa, Group CEO, Ambit
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.
I can understand if the tax was attracted and somebody omitted to pay it, in which case you say, look there must be some consequences, the law provides for consequences. But where the event does not attract the tax, then how can you over a period of time say that there is now a disincentive in relation to that?Rohan Shah, Tax Advocate
The memorandum to the Budget explains the tax change as an effort to counter "sham transactions".
“It has been noticed that 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.”
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.”
However, to protect the exemption for genuine cases where the Securities Transactions Tax could not have been paid like acquisition of shares in IPO, FPO, bonus or right issue by a listed company acquisition by non-resident in accordance with FDI policy of the Government etc., it is also proposed to notify transfers for which the condition of chargeability to Securities Transactions Tax on acquisition shall not be applicable.
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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