Lacunae in stock lending scheme must be removed

Samir Mogul

The purpose of the Stock Lending Scheme (SLS) introduced by Sebi was to improve liquidity, facilitate timely settlement of transactions and correct temporary imbalances of demand/supply in stock markets.
SLS permits securities lending by an approved intermediary (intermediary) to a borrower against collateral under an agreement for a specific time-frame with the pre-condition that the borrower returns equivalent securities of the same type/class along with corporate benefits accruing on the securities borrowed. The title of the securities rests with the lender.

Whether stock lending amounts to transfer?
Under section 2(47) of the Income Tax Act, 1961 (the Act), “transfer” in relation to a capital asset includes, under sub-section (i) the sale/exchange/relinquishment of an asset or, under sub-section (ii) the extinguishment of any rights therein.

Further, as per section 47(xv) of the Act inserted with effect from April 1, 1999, any transfer in a scheme for securities lending under an agreement entered into by the assessee with the borrower subject to Sebi guidelines in this regard, shall not be considered a transfer and hence, will not be taxable as capital gains.

Stock lending outside the purview of SLS of Sebi
In a case where A lends his shares directly to B without any formal agreement and more importantly, without routing the transaction through an approved intermediary, the transaction would be considered as a exchange/transfer as it is outside the purview of SLS and the exemption granted under section 47(xv) of the Act.
Hence, A will deemed to have sold the shares to B and will be liable to pay tax.

Lacunae
SLS has failed to meet its objectives and has been unsuccessful due to the following reasons:

1. Direct lending of securities is regarded as transfer and attracts taxes. It needs to be permitted without tax implications other than the interest component, especially when the lender is willing to take the risk just as in a regular loan transaction.

2. In an interesting case, the assessee stood as a guarantor for repayment of a loan taken by a company from Kerala Financial Corporation (KFC) and also mortgaged certain property belonging to her in KFC’s favour. When the company defaulted on the loan, in exercise of the rights under the mortgage deed, KFC sold the property and appropriated the entire proceeds towards discharge of the loan.
Hence, the entire consideration relating to the sale of property was paid directly by the purchasers thereof to KFC and thereafter the mortgaged property was released.

The assessee contended that this discharge of debt cannot be considered as consideration received or accrued and thus, did not include the same in her return of income.

Further, the assessee even stated that alternatively, the amount paid for discharging the debt was an expenditure incurred wholly and exclusively in connection with the transfer. So, the payment to KFC whose interest is secured, is eligible as a deduction under section 48(1)(a)(i) of the Act (as prevailing then) in computing the net consideration. Thus, the sale proceeds are not liable for assessment.
However, the assessing officer computed the capital gains stating that the assessee should be deemed to have received the entire sale proceeds.

The assessing officer’s view was supported by the higher authorities. However, the Kerala High Court held that KFC had acted in exercise of the overriding title in its favour arising out of the mortgage document and since, the assessee did not actually receive the amount, there could not be said to have been any income to the assessee much less any capital gains - Commissioner of Income Tax v Smt Thressiamma Abraham (1997 227 ITR 802).

Hence, applying the ratio of this case, surprisingly indirect lending of shares would not attract taxes.

3. Presently, there is no accounting standard or guidance note issued by The Institute of Chartered Accountants of India for uniform accounting of stock lending/borrowing transactions, especially where the entire transaction (return of securities) is not completed by the end of the financial year.

With the global stock markets meltdown, SLS needs to be suitably amended to to resolve the above lacunae.