The long-term capital gains on sale of listed equity shares have been exempted under Section 10(38) of the Income-Tax Act, 1961 (I-T Act). This exempted provision invited a lot of foreign investment in the country. However, on various occasions, it was exploited to avoid tax. The stock market regulator Sebi, on many occasions, has highlighted the alleged transactions undertaken by various entities exploiting the exemption provisions under the I-T Act. Taxpayers, via these sham transactions, were declaring their unaccounted income and claiming it as an exempted long-term capital gain. It was identified that certain preferential issue of shares have been executed in the past few years by the thinly-traded corporates taking the benefit of Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2009. These require to hold the preferentially issued shares for a period of more than one year.
The preferential issue of shares was undertaken specifically for subverting the lacunae of the provisions of Section 10(38) exemption, which does not require that the securities transaction tax (STT) be paid at the time of acquisition by the current transferor of the shares.
Sebi has brought this also to the notice of income-tax authorities. The existing government, in view of its policy of plucking the lacunas in the I-T Act without major overhauling of the provisions, through Finance Act 2017, has inserted a rider to Section 10(38). This rider was inserted to confine the exemption to transactions, which, at the time of acquisition by the transferor, have also been undertaken on or after October 1, 2004, through recognised stock exchanges by paying STT. Further, to safeguard genuine cases, the proviso lays for notifying the situations where exemption of Section 10(38) will be available even when STT was not paid on acquisition. The recent notification (No. 43/2017 dated June 5, 2017) by the Central Board of Direct Taxes (CBDT) is a relief to the genuine taxpayers holding shares as long-term investment.
This notification is more detailed compared to the draft issued on April 3, 2017, and addresses the concerns of various stakeholders and industry experts.
It has addressed genuine transactions, but instead of directly specifying exempted transactions, it indirectly notified the following three taxable ones where exemption under Section 10(38) will be prohibited:
(1) Shares of a listed company which are not frequently traded and where acquisition was through preferential issue;
(2) Acquisition of existing listed equity share in a company is outside recognised stock exchange;
(3) Shares acquired during the period the company was delisted from the recognised stock exchange.
However, to avoid hardship, protection is given by the notification to the cases where acquisitions were made by the transferor under any of the following circumstances:
Acquisition approved by Supreme Court/High Courts/NCLT/Sebi/RBI;
Acquisition by a non-resident in accordance with FDI guidelines;
Acquisition by Category I & II Alternative Investment Fund under Section 115UB, Venture Capital Fund under Section 10(23FB), or Qualified Institutional Buyer;
Acquisition through preferential issue to which chapter VII of the Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2009, does not apply;
Acquisition by scheduled banks/reconstruction or securitisation companies/public financial institutions; Acquisition via ESOP under scheme approved by Sebi regulations;
Acquisition under Sebi (Substantial Acquisition of Shares and Takeovers) Regulation, 2011;
Acquisition from the government;
Acquisition under sections 47 (i.e. distribution on partition of HUF, transfer by subsidiary to parent or vice-versa, under scheme of amalgamation, demerger, conversion of preference to equity, transfer under gift/will, etc) or 50B of the I-T Act if the previous owner has not acquired shares through any of the restricted modes.
The CBDT, vide the notification, has clearly sent a signal to foreign investors that they shall not be bothered where an acquisition was made through genuine mode following regulations placed by Sebi and RBI. The domestic investors making investment under any of the exclusions shall continue to be entitled for Section 10(38) exemption. Issues concerning ESOPs has been addressed and excluded from the list of taxable transactions.
However, rights issue, bonus issue, issue of sweat equity shares are not specifically excluded from the taxable transactions listed by the notification. But a view could still be taken that, since these are outside the definition of preferential issue and also the notification itself states at the beginning that all transactions are notified to be outside the purview of the newly inserted rider under Section 10(38) except those situations which are mentioned in the notification, therefore, rights issue, etc, shall still be eligible for exemption under Section 10(38), provided the sale is on a recognised stock exchange in a regularly traded company and with payment of STT.
Tax avoidance by resorting to practices subverting the law is a cause of concern for government authorities, and the amendment and issuance of notification is a step in the direction to curb such practices. This is also an effort to prevent the misuse of the exemption provisions of Section 10(38). These provisions are effective from FY18, i.e. AY19.
The authors, Pancham Sethi is senior manager, direct tax; KS Mehta is managing partner, SS Kothari Mehta & Co, Chartered Accountants