Promoters and private equity investors who have sold their shares via the offer for sale route in IPOs face potential tax challenges as a result of a Budget clarification imposing capital gains tax on such sales.
The central government has actually plugged a key loophole in the capital gains tax rules. Many promoters and investors declared zero capital gains on the grounds that there was no explicit provision for calculation of capital gains in this specific scenario and hence. the sale of shares was exempt from taxes.
Now, the central government has plugged the loophole in the rules with retrospective effect from February 1, 2018, bringing the older deals under the ambit of the clarification.
“Historically, there existed a degree of uncertainty regarding the application of the rules to shares transferred under an OFS that were not listed at the time of transfer but were nonetheless subject to STT. To address this ambiguity, the Finance (No.2) Bill of 2024 proposes an amendment to extend the existing rules for cost of acquisition to include shares disposed of through an OFS during an Initial Public Offering (IPO) and provide for indexed cost of acquisition.” Said Suresh Swamy, Partner, Price Waterhouse & Co LLP. “This amendment is designed to be applied retrospectively, effective from April 1, 2018. As a result, there may arise instances of reassessment for taxpayers who previously adopted a stance of Nil capital gains on the transfer of such shares.”
As a result, promoters and private equity investors who filed such nil capital gains returns could face re-assessment and fresh tax demands, say tax experts. The Income tax rules permit the tax department to open any filing for reassessment that are less than five years old.
The development assumes significance as dozens of promoters and private equity funds have exited investments through Initial Public Offerings(IPOs) in the last few years. IPO are usually a combination of issue of fresh equity shares and promoters and other investors selling part of their stake through what is referred to as the offer for sale (OFS) route.
“Certain promoters and PE investors, while offering their shares in OFS for IPO, could have taken a stand that in the absence of a clear provision relating to cost of acquisition for such shares, the entire gain should not be taxable. However, the clarificatory amendment has not only plugged a loophole, but also brought past transactions under the scanner since the amendment is applicable retrospectively,” said Rajesh Gandhi, partner, Deloitte.
Until 2018, long term capital gains(LTCG) for listed stocks were tax free. However, the government removed this exemption in the budget for FY19. While removing the LTCG tax exemption, the central government notified a special LTCG rate of 10 percent for transactions where the securities transaction tax (STT) was paid both during the purchase and sale of shares. Since, in case of IPOs, promoters couldn’t have paid STT during purchase of shares, a special exemption was provided for such cases saying a 10 percent rate would also apply in case of IPOs, provided STT is paid during the transfer of shares.
The rules also specified how fair market value (FMV) of these shares needs to be calculated to determine acquisition costs since the company was unlisted before. In case of IPOs, however, the transfer of shares happens while the company is still unlisted and the question of paying STT doesn’t arise until 3-5 working days when the shares get listed.
Several promoters and PE investors took a view that since the shares were unlisted on the date of transfer, there was no need to calculate FMV and hence there was no tax liability. Now, the government has clarified on this issue with effect from February 1,2018.
Tax experts say the rules never meant to provide tax exemption for sales through the OFS route. However, some of the promoters and funds were aggressive in their interpretation of the rules.
“The proposed amendment is clarificatory in nature and states the law as was always intended to be. The position taken by the promotes or PE investors was based on the literal reading of the law and interpreted beneficially by them. The intent of the law was never to exempt such capital gains but only to provide appropriate FMV for OFS transactions. The clarificatory amendment will provide certainty of taxability in OFS transactions,” said Punit shah, partner, Dhruva Advisors.
OFS has become a very popular route for promoters and early-stage investors to cash in, and over the years it has become a major factor for many companies choosing to list. According to data compiled by CNBC TV18, during 2022 and 2023, markets witnessed 75 IPOs on the main bourses, of which 14 were 100 percent OFS and 46 had an OFS component. Only 14 IPOs during the period did not have any OFS component, data showed.
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