New tax plans worry market participants

Wording of draft circular spells uncertainty for ESOPs, off-market transactions and shares acquired through mergers

Aset of proposals for capital gains tax on shares acquired without paying the Securities Transaction Tax (STT) is creating nervousness in the stock markets. The government has asked for reactions to be sent by the coming Tuesday. Legal experts say the wording of the draft notification could expose employee stock options (ESOPs) and off-market share purchases to capital gains. According to the circular's Clause (B), acquiring any listed company's shares other than through a recognised stock exchange would attract capital gains. Although ESOPs are commonly considered subscriptions, several judgments delivered by courts have highlighted that these are purchases made by employees in the form of services rendered to the company. Also, allotment of ESOPs doesn’t take place on a stock exchange platform. Hence, ESOPs would attract Clause (B).

“If the intention is not to tax ESOPs, there should explicitly be an exception in the final circular,” said Amit Singhania, partner, Shardul Amarchand Mangaldas.

Experts say the circular could also end impact many other genuine transactions, including off-market ones and shares acquired through mergers and acquisitions (M&As).

Off-market transactions are share transfers outside of a stock exchange platform. The route is commonly used to transfer shares within a family, for inheritance purposes. The route is also used during purchase agreements between the promoter of a company and strategic investors. The advantage of conducting such transactions outside a stock exchange is insulation from a fall in share prices as a result of volumes generated due to the deal.

“The open wording of Clause (B) might have wider ramifications. Exposing such genuine transactions to the proviso would only cause hardships to the business, and is against the genesis behind introduction of the measures,” said Ravi Mehta, partner, Grant Thornton.

What is making the market more nervous is that the provisions would apply to shares sold after October 1, 2004, when the STT regime came into effect. The tax authority has specified three scenarios that would attract capital gains tax. Clause (A) deals with acquisition of shares through preferential allotment in listed companies which are not traded frequently. The second scenario (Clause B) involves listed shares bought outside an exchange platform. A third scenario (Clause C) is on acquisition of shares while a company is delisted and before it gets listed again.

Through these measures, the government says it aims to curb the practice of declaring unaccounted income as exempted long-term capital gains, via sham transactions. As mentioned, the market worries that the impact will also fall on genuine M&As and ESOPs.