Union Budget 2018: Long-Term Capital Gains Tax - The Unanswered Questions
It’s been a little over two weeks since the Finance Minister announced the reintroduction of long-term capital gains tax. Effective April 1, 10 percent tax will be levied on capital gains made on the sale of listed equity shares exceeding Rs 1 lakh and sold after a year of purchase. To the relief of investors, gains up to Jan. 31 this year have been grandfathered i.e. they won’t be subject to tax.
The tax department recently issued an FAQ clarifying the methodology to calculate the gains, date from which the holding period will be counted, benefit of the grandfathering provisions for bonus and rights shares.
But the implications of this tax on inherited shares, mergers, demergers and initial public offers continue to confound experts.
LTCG Tax: Fate Of Inherited Shares
The applicability of LTCG tax on shares inherited after Jan. 31, 2018 is not clear.
For instance, if X acquired shares in March 2002 and they were inherited by Y on Feb. 15, 2018, it’s not clear if Y will benefit from the grandfathering provision. The language of the LTCG tax section states that to avail this benefit, the person should have held those shares as of Jan. 31, 2018.
In the absence of any clarification, the long-term capital gains will be calculated based on the purchase price in March 2002 since Y did not own the shares as of Jan. 31, 2018, Amrish Shah, M&A tax head at Deloitte Haskins & Sells pointed out.
The person who has inherited the shares - as per the provision today- is not entitled to the fair market value replacement as on Jan. 31, 2018. To that extent, you will go back to the cost because the law provides for cost replacement. So, the cost of acquisition in hands of the parent will be considered as the basis if the share has to be sold on and after April 1, 2018. So, the period and cost will be counted of the personAmrish Shah, Head - M&A Tax, Deloitte Haskins & Sells
Vivek Gupta, M&A head at KPMG India disagreed and said he expected the grandfathering benefit to apply. Gupta concluded this on a 2017 tax department circular that extended the LTCG tax exemption to genuine securities transaction even if no STT had been paid. This after the union budget 2017 had withdrawn the tax benefit in cases where STT was not paid.
Relying on that and the FAQs released after this year’s budget speech, Gupta reiterated that the benefit of grandfathering of gains up to Jan. 31 will be extended to all genuine transactions, including inherited shares.
At the time of inheritance, no STT is paid. But if the 2017 notification is extended for the purpose of the LTCG section, then the fact that STT is not paid will not dis-entitle me from the Jan. 31 step up. If I were to take that statement at face value, it will mean that the benefit which would have been available in respect of all the situations which were addressed by 2017 notification will continue to be available even in the context of LTCG section.Vivek Gupta, Head - M&A, KPMG India
He added that what the government has not done is specify inherited shares by name right now in the FAQ but it’s implicit in the drafting.
LTCG Tax: Fate Of Mergers And Demergers
The second area of ambiguity is whether mergers and demergers will get the benefit of the grandfathering provisions. Several ongoing transactions, for instance the IDFC Bank Ltd.-Capital First Ltd. merger and IIFL Ltd.’s demerger, will run into this problem if the government doesn’t clarify its position. As per the latest data on the Securities and Exchange Board of India’s website, 22 schemes of arrangement are in the works.
Take the example of a court approved merger of company A and B that becomes effective post April 1. Let’s say the shares of company A’s shareholders get cancelled and they get shares of company B. Shah explained that it’s not clear if the shareholders of company A will get the benefit of grandfathering provisions since they didn’t hold shares in company B as on Jan. 31, 2018.
There is no concept of fair market value replacement – so fair market value of company A as on Jan. 31, 2018 cannot be replaced with that of company B. A lot of representations are being made and I feel that the government will clearly clarify because I don’t think the intention is to not provide for the benefit, especially to genuine cases of mergers that may be happening.Amrish Shah, Head - M&A Tax, Deloitte Haskins & Sells
Gupta pointed out that demergers will face similar confusion. In the case of demerger the company undergoing it will issue new shares as will the resultant company. It’s not clear if the grandfathering benefit will be available for shares of the resultant company.
Question arises that my value today includes the value that is being demerged into the resulting company. Therefore, it includes the value of resulting company shares too in my Jan. 31 quote. However, the way the law is worded, for the shares of resulting company, since that company could perhaps not be listed as of Jan. 31, I will not get the benefit of re-statement of my cost base to Jan. 31 fair market value because none exists.Vivek Gupta, Head - M&A, KPMG India
Similar confusion will cloud convertible securities too that were not held as shares as on Jan. 31, 2018.
LTCG Tax: Fate Of IPOs, FPOs
The final challenge will be for initial public offers and follow-on public offers currently in the works.
Exiting shareholders would have to pay LTCG tax based on their original acquisition cost, Shah said.
As of Feb. 9, work on 18 initial public offerings is underway, including the National Stock Exchange of India Ltd. and Bandhan Bank Ltd. IPOs.
Take the example of a promoter or a technocrat who has built the company 10 years back and acquired the shares at par value. But the Discounted Cash Flow or Net Asset Value - higher of the two, is Rs 100 - and he is doing an IPO at Rs 130. Then should he be taxed Rs 130 minus his original cost of Rs 10 or should he be taxed on Rs 130-100 which is the replaced value as of Jan. 31, 2018? There is a fair ask that it should be only on Rs 30 which is Rs 130-100. Because then you equate that with listed stocks.Amrish Shah, Head - M&A Tax, Deloitte Haskins & Sells
Gupta doesn’t view the situation as unfair as the shares will list only after the Jan. 31 deadline.
Only dichotomy is when I have filed for IPO, I would have been planning for a tax regime where any further sale of that equity would not have attracted any tax and now I am stuck with 10 percent tax. But that is the change of law that has occurred. The way the law is worded at this point of time, the Jan. 31 step up will not be available because there is in any case no traded price available as of that date.Vivek Gupta, Head - M&A, KPMG India