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PEs, VCs want clarity on long-term capital gains

NEW DELHI, Feb 2:  With the Budget proposing to withdraw long-term capital gains tax exemption if shares were purchased without paying STT, venture capital and private equity investors want clarity from the government to keep their investment in unlisted firms and the ESOPs exempted.
While the new provision is mainly aimed at checking misuse of this exemption for tax evasion through ‘sham transactions’ in stock market, it also provides for continued exemption for “genuine cases” where STT could not have been paid like in acquisition of shares in IPOs, FPOs, bonus or rights issue of shares by listed firms by non residents.
However, there is no mention of ESOPs or purchase of shares in unlisted companies by PE or VC investors who typically seek to sell their shares post listing and therefore STT (Securities Transaction Tax) may not have been charged at the time of purchase of shares or grant of ESOPs.
The investors and the start-ups, where a trend is prevalent for grant of ESOPs and investment by PEs and VCs much before listing, fear that the proposed amendment to rules governing tax exemptions for long-term capital gains could potentially place an onerous tax burden on such transactions.
Therefore, they want clarity of application of new rules.
Currently, the income arising from transfer of long-term capital asset, being equity share of a company or a unit of an equity-oriented fund, is exempt from tax.
Eminent chartered accountant S Ravi said the announcement of allowing LTCG exemption for income arising on transfer of equity shares acquired or on after October 1, 2004 only if the acquisition of shares is chargeable to STT would curb evasion of capital gains via investment in spurious companies.
“It is expected that the Finance Ministry would provide clarifications shortly to exclude genuine transactions such as FDI, ESOPs, IPOS, bonus issues which do not attract STT on acquisition,” said Ravi, who is managing partner of Ravi Rajan & Co and an independent director on the board of public limited companies.
“However, till the matter gets clarified, the tool of ESOPs/sweat equity which was utilized to motivate employees in start-ups stands destabilized on account of taxation concerns.
“Besides, many corporate houses using the method of gifting listed shares for effective tax planning as well as PE investors having received preferential allotment of shares in off-market transaction may face the burden of taxation in the financial year 2017-18,” he added.
There is apprehension that any sale of employee stock ownership plans (ESOPs) might also attract long-term capital gains tax as STT was not paid when the ESOPs were issued. ESOPs granted before 2004 might also be taxed if not notified.
The long-term capital gains from sale of unlisted shares in the hands of non-residents attract a tax of 10 per cent.
“With a view to preventing this abuse, it is proposed to amend section 10(38) to provide that exemption under this section for income arising on transfer of equity shares acquired or on after October 1, 2004, shall be available only if the acquisition of shares is chargeable to STT,” said the memorandum to the Finance Bill 2017.
However, to protect the exemption for genuine cases where STT could not have been paid like acquisition of share in IPO, FPO, bonus or right issue by a listed company acquisition by a non-resident, it has been proposed “to notify transfers for which the condition of chargeability to STT on acquisition would not be applicable”.
This amendment will take effect from the assessment year 2018-19.
IVCA President Rajat Tandon said, “It is not clear if VC/PE investments in unlisted shares will suffer higher rates of LTCG taxation when sold after the IPO event”.
“An unintended consequence of this rule is to potentially place an onerous tax burden on ESOPs — which represent the most powerful wealth creation instrument that cash-strapped start-ups use to motivate employees — when their shares are sold post-listing,” he added.
IVCA intends to initiate a dialogue with Finance Ministry on this matter and ensure that the exclusion notification covers all transactions related to Sebi-registered VC/PE funds, such as Domestic Venture Capital Funds (DVCFs) and AIFs, Tandon said. (PTI)

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