This note intends to analyse the draft notification issued by the Central Board of Direct Taxes (the "CBDT") under the third proviso to the clause (38) of section 10 of the Income Tax Act, 1961 ("Draft Notification") highlight its impact on the primary and secondary market transactions.
Securities Transaction Tax
Section 10(38) of the Income Tax Act, 1961 (the "Act") (prior to its amendment by Finance Act, 2017) provided that the income arising by way of a transfer of long term capital asset, being equity share in a company, shall be exempt from tax if such transfer is undertaken after 1st October, 2004 and is chargeable to Securities Transaction Tax ("STT") under Chapter VII of the Finance (No. 2) Act, 2004.
The Finance Act, 2017 ("Finance Act") has amended the provisions of Section 10(38) of the Act to provide that the aforementioned exemption from payment of long term capital gains tax shall be available only if the acquisition of share is chargeable to STT. However, since this amendment could also impact certain genuine transactions, the Finance Act provides that the Central Government shall notify the transfers for which the condition of chargeability to STT shall not apply.
Accordingly, the CBDT has, vide its press release dated April 3, 2017, issued the Draft Notification which proposes to codify the exemptions available from the applicability of STT in section 10(38) of the Act. The Draft Notification, instead of providing an exhaustive list of transactions, proposes a negative list of certain specified transactions for which exemption from payment of long term capital gains tax would not be applicable. The Draft Notification proposes the following list of specified transactions.
- The exemption will not be available for acquisition through preferential allotment of listed equity shares of a company whose equity shares are not traded frequently on the stock exchanges. However, the exemption will be applicable to preferential issues to which provisions of chapter VII of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements), Regulations, 2009 (the "SEBI ICDR Regulations") does not apply. The Draft Notification defines 'frequently traded shares' to mean shares of a company, in which the traded turnover on a stock exchange during the twelve calendar preceding months, is at least ten percent of the total number of shares of such class of the company.
- The exemption will not be available where the purchase of listed equity share in a company is not entered through a recognized stock exchange.
- The exemption will not be available where the equity shares of a company are acquired during the period beginning from the date of which the company is delisted from a stock exchange and ending on the date on which the company is re-listed on the stock exchange in accordance with the Securities Contracts (Regulation) Act, 1956 read with Securities and Exchange Board of India Act, 1992 and any rules made thereunder.
Impact of the Draft Notification
The Draft Notification directly impacts listed companies whose shares are thinly traded. As per point (a) of the Draft Notification, preferential issues of equity shares of companies whose equity shares are thinly traded, on or after October 1, 2004, will be required to fulfil the condition of payment of STT at the time of acquisition of the equity shares. However, as the negative list does not include preferential issues to which the provisions of chapter VII of the SEBI ICDR Regulations does not apply, the exemption will be applicable to the following transactions in accordance with Regulation 70 of the SEBI ICDR Regulations:
- issue of equity shares made pursuant to conversion of loan or option attached to convertible debt instruments in terms of sub-sections (3) and (4) of sections 62 of the Companies Act, 2013;
- issue of equity shares pursuant to a scheme approved by a High Court under section 391 to 394 of the Companies Act, 1956 or a Tribunal under sections 230 to 234 of the Companies Act, 2013, as applicable; and
- issue of equity shares in terms of a rehabilitation scheme approved by the Board of Industrial and Financial Reconstruction under the Sick Industrial Companies (Special Provisions) Act, 1985 or the Tribunal under the Insolvency and Bankruptcy Code, 2016, as applicable.
Point (b) of Draft Notification, states that the exemption from payment of STT under Section 10(38) of the Act will not be available in the event there has been a purchase of listed equity shares of a Company which is not entered through a recognized stock exchange. However, since point (b) of the Draft Notification is very broadly worded and does not include a list of specific transactions, it is unclear whether it would also impact genuine off-market transactions, such as transactions involving acquisition of shares by strategic investors and private investors or transactions involving transfer of promoter shares (including inter-se promoter transfers for the purpose of corporate restructuring). It is also ambiguous whether point (b) of the Draft Notification would impact acquisition of shares by way of gift or inheritance or acquisition of shares by employees pursuant to employee stock option scheme of a listed company.
The CBDT has invited all stakeholders to provide their comments and suggestions on the draft notification by April 11, 2017. It is hoped that CBDT will provide clarification and address the concerns of the stakeholders pursuant to the consultative process.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.