Private equity investors puzzled over capital gains tax applicability

It’s been four months since the new tax on capital gains took effect. However, some sections are still puzzled over its applicability. Private equity (PE) investors have written to the Central Board of Direct Taxes (CBDT), seeking clarity on tax on gains made through sale of shares in recent initial public offerings (IPOs).


While the rules are clear for the listed space, with January 31, 2018, set as the reference day for computing cost of acquisition, there is still ambiguity on the unlisted space. As companies that are floating IPOs were unlisted as on January 31, their market price is not available for calculation of long-term capital gains (LTCG), which is the difference between cost of selling and acquisition.

IPOs have become a preferred route for PEs to sell their stakes. Of the Rs 204-billion raised through IPOs this year, Rs 139 billion is on account of Offer for Sale (OFS) by promoters and PE investors. Investment bankers say more than half of the Rs 200-billion IPO pipeline consists of OFS by PEs and existing shareholders.


“We have given a representation to both the finance ministry and CBDT on how the capital gains would be calculated. While the authorities have already expressed their intent to provide fair rules for genuine market transactions such as IPOs, there are still doubts,” said a source.


Two views are emerging in the market on this. First, merchant bankers could be asked to calculate the fair market value (FMV) of a company's shares as on January 31 and consider it the reference price. However, the authorities have reservations, since FMV is open to interpretation. Also, there are concerns that companies could keep the FMV on par with the IPO price, to avoid showing any capital gain.


The second scenario for companies where there is no publicly disseminated price available is that the benefit of grandfathering would not be extended.


“Both views are legally plausible but it will be good if the CBDT clarifies” said Amit Singhania, partner, Shardul Amarchand Mangaldas.


The central government had reintroduced an LTCG tax after 15 years. All this while, sale of shares held for more than 12 months in a listed company were exempt from this tax. From April 1, even shares held for more than a year were subject to capital gains tax. To apply the law prospectively, the government introduced grandfathering for existing investments; essentially exempting all gains made before introduction of the new law from its ambit.


Under the new rules, shares held for more than a year will be subject to 10 per cent capital gains tax, while shares held for less than a year are subject to 15 per cent. These rates would only apply if Securities Transaction Tax was paid during purchase of shares.

Tax Trouble

  • PEs seek clarity on how LTCG would be applicable on sales of shares via IPO
  • For listed companies, market price as on January 31 is considered for calculating LTCG 
  • However, IPO-bound companies were not listed as on January 31 and hence market price as on the day is not available
  • The issue assumes significance as IPOs have become favoured routes for PE investors to sell their stake in unlisted companies