Introduction

Until 31 March 2017, long-term capital gains arising on the transfer of listed equity shares were exempt from tax in India if such transfer was undertaken on a recognized stock exchange and Securities Transaction Tax (STT) was paid on the same. To prevent the misuse of this exemption, the Indian income-tax laws were amended whereby from 1 April 2017, the benefit of this provision has been limited to transactions where STT was also paid at the time of acquisition of the shares sought to be transferred, provided such shares were acquired on or after 1 October 2004 (Amendment).

However, to protect genuine cases where it was not possible to have paid STT for acquisition of listed shares, it was clarified that the Indian Government would notify those acquisitions to which the Amendment shall not apply. Consequently, on 3 April 2017, the Central Board of Direct Taxes (CBDT) issued a draft notification (Draft Notification) listing out such acquisitions which would be impacted by the Amendment. The Draft Notification created much anxiety amongst investors, as highlighted in our Newsflash dated 5 April 2017.

Pursuant to receiving comments from various stakeholders, the CBDT has issued the Final Notification (Notification) wherein several of the investor concerns have been resolved.

Notification

The Notification sets out a negative list and provides that except for certain transactions of acquisition of equity shares (entered on or after 1 October 2004) which are covered in that list, the acquisition of shares under all other transactions which did not result in payment of STT at the time of acquisition would be eligible for the long-term capital gains tax exemption, provided STT was paid at the time of its transfer.

The following 3 (three) categories (Three Categories) of acquisition of listed shares would not qualify for the exemption, if STT was not paid at the time of acquisition of such shares:

A. Thinly Traded shares (First Category)

This category refers to an acquisition of existing listed equity shares by way of preferential issue of a company whose equity shares are not frequently traded on a recognized stock exchange.

It is to be noted that while this category deals with a preferential allotment of shares, the usage of the words ‘acquisition of “existing” listed equity shares’ leads to an inconsistency /ambiguity within the scope of this provision as a ‘preferential issue’ would always entail a fresh issue of shares.

However, shares acquired in the following modes are an exception to the abovementioned condition:

  1. Pursuant to an approval from the Supreme Court (SC), High Court (HC), National Company Law Tribunal (NCLT), Securities and Exchange Board of India (SEBI) or the Reserve Bank of India (RBI);
  2. By a non-resident in accordance with the foreign direct investment guidelines (FDI Guidelines) issued by the Government of India;
  3. By a Category I or a Category II Alternative Investment Fund (AIF) as regulated under the SEBI (Alternate Investment Fund) Regulations, 2012 (AIF Regulations) or by a ‘venture capital fund’ as defined under Section 10(23FB) of the Income Tax Act, 1961 (IT Act); or
  4. Through a preferential issue of shares to which the provisions of Chapter VII of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 does not apply.

Thus, the acquisitions covered in the aforementioned modes would continue to be eligible for the long-term capital gains tax exemption, provided STT is paid at the time of transfer of such shares, even though STT is not paid at the time of its acquisition.

B. Off-market acquisitions (Second Category)

This category refers to a transaction for acquisition of existing listed equity shares of a company not entered through a recognized stock exchange.

However, shares acquired under the following modes are an exception to the abovementioned condition, provided such listed equity shares are acquired in accordance with the Securities Contracts (Regulations) Act, 1956 (SCRA) (as may be applicable):

  1. Through an issue of shares by a company, other than the mode of issue referred to in the First Category above;
  2. By scheduled banks, reconstruction or securitization companies or public financial institutions during their ordinary course of business;
  3. Pursuant to an approval by the SC, HC, NCLT, SEBI or the RBI;
  4. Under an employee stock option scheme (ESOP scheme) or employee stock purchase scheme framed under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 (ESOP Guidelines);
  5. By a non-resident in accordance with the FDI Guidelines issued by the Government of India;
  6. Under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011;
  7. Acquired from the Government of India;
  8. Acquired by a Category I or a Category II AIF as regulated under the AIF Regulations or by a ‘venture capital fund’ as defined under Section 10(23FB) of the IT Act; or
  9. Acquired by way of:
  • gift, inheritance, on conversion of preference shares / debentures into equity shares or other exempt modes of transfer mentioned under Section 47 of the IT Act; or
  • a slump sale as defined under Section 50B of the IT Act.

However, in such cases the previous owner of such shares should not have acquired the shares by any of the modes mentioned within the Three Categories.

Thus, the acquisitions covered in the abovementioned scenarios would continue to be eligible for the long-term capital gains tax exemption, provided that STT is paid at the time of transfer (even though STT was not paid at the time of acquisition).

C. Acquisition of equity shares during the period between delisting and re-listing of a company (Third Category)

This refers to equity shares acquired during the period between delisting of a company from a recognized stock exchange and its re-listing on a recognized stock exchange in accordance with the SCRA and the regulations enacted under the SEBI Act.

Comment

The Notification resolves many concerns which arose out of the Draft Notification. It portrays that the Indian Government is making an effort towards achieving its objective of protecting genuine transactions and promoting a non-adversarial tax regime. It also provides much-anticipated relief to non-residents investing under the FDI guidelines.

While the provisions of the Notification provide protection to most forms of transactions, including FDI investments by non-residents, it does not specifically provide exemptions to resident investors for investment(s) made via an off-market acquisition of listed equity shares. Therefore, off-market investment(s) by resident investors shall attract long-term capital gains tax at the time of exit unless they are specifically covered within any of the exceptions mentioned in the Notification. Further, the Notification refers to ESOP schemes framed under the ESOP Guidelines, which has been replaced by the SEBI (Share Based Employee Benefits) Regulations, 2014. We hope that this is unintentional and a necessary clarification is provided regarding the same. Additionally, Category III AIFs have not been extended the same benefits as have been provided to Category I and Category II AIFs under the Notification.