India: CBDT Issues Final Notification On 10% Tax Rate For Certain Transactions

BACKGROUND

The Finance Act, 2018 (the "FA, 2018") introduced Section 112A into the Income Tax Act, 1961 (the "Tax Act") with effect from April 01, 2018 wherein it stipulated that the capital gains of more than INR 1,00,000 received for alienation of equity shares of a company shall be taxable at the rate of 10%, provided that the Securities Transaction Tax ("STT") should be paid at the time of acquisition as well as transfer of such equity shares. However, the Government was supposed to notify certain modes of acquisition of shares wherein the requirement to pay STT at the time of acquisition would not apply. Accordingly, the Central Board of Direct Taxes ("CBDT") issued a draft notification on April 24, 2018 ("Draft Notification")1 wherein it specified rules and exceptions with regard to payment of STT in relation to certain transactions. A detailed analysis on the Draft Notification can be found in our hotline available here.

In furtherance of the same, and after almost 6 months from when the Draft Notification was issued for comments, the CBDT has now come out with the final notification, dated October 01, 2018 ("Final Notification") in this regard.

THE FINAL NOTIFICATION

The Final Notification issued by CBDT is identical to the Draft Notification, barring few additions. Similar to the Draft Notification, the Final Notification has specified that the requirement to pay STT will not apply to (1) share acquisitions undertaken prior to October 1, 2004, (2) share acquisitions undertaken on or after October 1, 2004, subject to certain exceptions, viz.,

(a) An acquisition by way of a preferential allotment of shares that are not frequently traded2 in a recognized stock exchange of India except where:

Sr. No. Draft Notification Final Notification
01. the acquisition has been approved by the Supreme Court, a High Court, the National Company Law Tribunal ("NCLT"), the Securities and Exchange Board of India ("SEBI") or the Reserve Bank of India ("RBI") in this behalf. No change.
02. the acquisition is by any non-resident in accordance with foreign direct investment guidelines issued by the Government of India. No change.
03. the acquisition is by a fund registered with the SEBI as a Category – 1 Alternate Investment Fund ("CAT I AIF"), a Category – 2 Alternate Investment Fund ("CAT II AIF") or a venture capital fund ("VCF"), or a Qualified Institutional Buyer ("QIB")3. No change.
04. the acquisition is pursuant to a preferential issue to which the Chapter VII of the SEBI (ICDR) Regulations4 does not apply. No change.

(b) An acquisition through an off-market transaction, where listed shares5 are not acquired on the floor of the stock exchange, except where:

Sr. No. Draft Notification Final Notification
01. the acquisition is through an issue of share by a company other than the preferential issue as mentioned under (a) above. No change.
02. the acquisition is by a scheduled bank, reconstruction or securitization company or public financial institution during the ordinary course of business. No change.
03. the acquisition has been approved by the Supreme Court, a High Court, the NCLT, the SEBI or the RBI, in this behalf. No change.
04. the acquisition is under an employee stock option scheme or employee stock purchase scheme framed under the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 ("ESOP Guidelines"). No change.
05. the acquisition is by any non-resident in accordance with foreign direct investment guidelines of the Government of India. No change.
06. the acquisitions of shares of company is made under Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulation, 2011 ("SEBI (SAST) Regulations"). No change.
07. the acquisition is from the Government. No change.
08. the acquisition is by a SEBI registered CAT-1 AIF, CAT-2 AIF or VCF, or a QIB No change.
09. the acquisition is by mode of transfer not considered a transfer under sections 47 of the Tax Act or by way of a slump sale (as defined under section 50B of the Tax Act) if the previous owner of such shares acquired them pursuant to a mode of acquisition notified under the draft notification. the acquisition is by mode of transfer not considered a transfer under section 47 of the Tax Act or by way of a slump sale (as defined under section 50B of the Tax Act); or by way of transfer of a capital asset by a person to a firm or other association of persons or body of individuals as stipulated under section 45(3) of the Tax Act; or by way of transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals as stipulated under section 45(4) of the Tax Act, if the previous owner of such shares acquired them pursuant to a mode of acquisition as notified under the Final Notification.

(c) An acquisition of de-listed shares:

Sr. No. Draft Notification Final Notification
01. Listed shares acquired during a period between their de-listing and re-listing on the stock exchange. No change.

ANALYSIS

The Final Notification has been made effective from April 1, 2018 and should provide the much-awaited relief to the taxpayers.

Similar to the Draft Notification, the Final Notification also provides for a double negative listing of transactions wherein as a general rule, the acquisition transactions which are subject to payment of STT in order to avail of 10% tax rate for long- term capital gains have been provided followed by exceptions in the form of acquisition transactions wherein STT is not required to be paid to avail of the reduced tax rate.

Moreover, the Final Notification has also retained exemptions envisaged under the Draft Notification with respect to section 47 of the Tax Act, internal re-organisation involving listed shares, approved M&A schemes, etc. Further, it also continues to cover the exemption granted in case of acquisition of shares by Cat I AIFs, Cat II AIFs and VCFs taking into consideration that the majority of the investments done by these investment funds are in the unlisted space where STT is not required to be paid.

Furthermore, besides the exemptions that were stipulated in the Draft Notification, the Final Notification provides for two additional exemptions, viz., (i) cases where the capital gains have arisen by way of transfer of shares by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) as stipulated under section 45(3) of the Tax Act; or (ii) by way of transfer of shares by way of distribution of shares on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) as stipulated under section 45(4) of the Tax Act, provided that the previous owner of such shares acquired them pursuant to a mode of acquisition as has been provided under this Final Notification.

As mentioned in our hotline on the Draft Notification, while several ambiguities in relation to application of section 112A should get settled, there still remain few unrequited queries. For instance, it still remains unclear whether grandfathering would be available in case of a SEBI / National Company Law Tribunal ("NCLT") approved merger / de-merger of a listed entity wherein the shares have not actually been transferred to the shareholder(s) prior to January 31, 2018; or whether in case of conversion of the debentures of a listed entity into listed shares of the same entity after January 31, 2018, grandfathering benefit would be available; or whether in case of capital gains of up to INR 1,00,000 received by a resident would be exempt from taxation or would it be taxable at the rate of 20%.

While the exemptions stipulated under the Final Notification should definitely provide much needed comfort to the business community and foreign investors (FDI as well as FPI) in planning their proposed transactions, the Final Notification still does not take into account all the concerns of the industry and it is anticipated that the tax authorities would provide certainty on other unclear aspects as well.

Footnotes

1 Available at https://incometaxindia.gov.in/Lists/Latest%20News/Attachments/240/Draft-Notification-24042018.pdf

2 The notification defines "frequently traded shares" to mean shares of a company, in which the traded turnover on a recognised stock exchange during the twelve calendar months preceding the calendar month in which the acquisition and transfer is made, is at least 10% of the total number of shares of such class of the company, provided that where the share capital of a particular class of shares of the company is not identical throughout such period, the weighted average number of total shares of such class of the company shall represent the total number of shares.

3 A "Qualified Institutional Buyer" is defined under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 ("SEBI (ICDR) Regulations") and includes: registered mutual funds, VCFs, AIFs, foreign venture capital investors ("FVCIs"), public financial institutions, schedule commercial banks, registered insurance companies, multilateral and bilateral development financial institutions, state industrial development corporations, pension funds and provident funds with minimum corpus of INR 25 crores, the National Investment Fund, systemically important non-banking financial companies ("NBFC-SI") and insurance funds set up and managed by the Indian army, navy or air force or the Department of Posts.

4 Chapter VII of the SEBI (ICDR Regulations) sets out certain conditions pursuant to which a listed company may undertake a preferential allotment of shares. It does not apply where the preferential allotment is made (a) pursuant to conversion of a loan or option attached to a convertible debt instrument; (b) pursuant to a scheme approved by a High Court or the NCLT; (c) in terms of a rehabilitation scheme approved by the Board of Industrial and Financial Reconstruction ("BIFR") or a resolution plan approved by the Tribunal under the Bankruptcy and Insolvency Code, 2016.

5 The notification defines "listed" as listed in a recognised stock exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 and the rules made thereunder.

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.

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Authors
Ashish Sodhani
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