Off-market deals under scanner

Sebi asked to provide details of such transactions for FinMin and tax department to study them

The finance ministry has sought an “exhaustive list” of wide-ranging off-market transactions from the Securities and Exchange Board of India, to decide whether investors have to pay long-term capital gains (LTCG) tax under a new rule.

The proposed clause in this year’s Budget says those who acquired shares in unlisted companies after October 1, 2004, will have to pay LTCG if they hadn’t paid securities transaction tax (STT) at the time of purchase. At present, STT is not paid when shares are acquired in off-market transactions such as mergers and acquisitions, qualified institutional placements or private equity investments in unlisted companies. 

The ministry official and the tax department are working closely to finalise guidelines, to be issued after considering the concerns raised by market players, said the Central Board of Direct Taxes (CBDT).

“We are in touch with the capital market regulator. We had sought information about some of the categories of allotments/placements where checking can be done,” CBDT Chairman Sushil Chandra told Business Standard. “As a large number of persons are involved, we need to examine if back-dated purchases have been done or someone is taking advantage of LTCG exemptions. We are receiving a very exhaustive list from the regulator and, accordingly, we will come up with a clarification.”

The central government has clarified that transactions such as a rights or bonus issue or initial public offerings, foreign direct investments (FDI) where there is no incidence of STT would be exempt. But, there is lack of clarity on various categories such as private placements, employee stock options and the shares a company acquired before it gets listed.

“There is no need to worry at all on the issue. We have brought this as an ‘anti-abuse’ measures,” Chandra said. “This is not a revenue raising avenue for us. This provision will be exempting all genuine cases of allotment of shares without payment of STT. So, if there is a person who got shares out of IPO/FPO or if it is a genuine FDI coming via unlisted companies or bonus shares, these will not be covered. We are very clear on this.”

On the rationale behind the new clause, Chandra said, “It has been noticed during search operations that the exemptions provided are being misused by certain persons for declaring their unaccounted income as exempt LTCG by entering into sham transactions. In some cases, brokers were found misusing the LTCG exemption through off-market purchases. The new provision is for those utilising their money and converting it through penny stocks and jacking up prices to a particular level and then using the exit route to convert their black money into white.” 

Tax experts said the new provision could create confusion and there was no need for such clauses when the government would notify the General Anti-Avoidance Rules for preventing companies from routing transactions through other countries and avoiding taxes. “Why does the government require the new clause? It was  set to evoke anti-avoidance tax rules from April 1,” said Sudhir Kapadia, partner and national tax leader, EY India. “The adoption of anti-abuse rules in tax treaties helps target shell companies or holding companies, incorporated overseas to evade taxes by showing their residency as a tax haven, though the management and effective decision-making takes place in India.”

The market regulator’s surveillance mechanism is strong. Stock exchange systems raise an alarm in case of price manipulation, he said. “The new clause and the related exemptions would only create confusion among market participants. This has to be only for penny stocks, created with the intent of evading long-term capital gains tax,” he added.