The Hindu Business Line : Private deals on public platform

A stock exchange by definition enures for facilitating exit to investors who want to encash their holdings besides simultaneously being the entry point for those having the stomach for volatility and patience for rewards.

More than one case

But thanks to a mysterious stock exchange regulation in India, strictly private deals between parties are allowed to go through a stock exchange. The Ambani brothers reportedly used the stock exchange’s bulk trading platform to settle their private dispute and carve out independent empires for themselves. So did the promoters of Satyam computers.

And these two aren’t the only ones. Many family-controlled companies in India have taken advantage of this latitude to clear the cobwebs of cross-holdings at the time of family settlement marked by balkanisation of the business empire assiduously built by their forebears.

There are reports doing the rounds that the Singh family, the outgoing promoters of Ranbaxy, is holding out so as to be able to clamber on to the stock exchange’s bulk trading platform. Unfortunately for them, however, the task seems to be impossible given the fact that private deals are allowed to be consummated through this platform only at a price which is within 1 per cent range of the prevailing quotations and the gap between the price, Rs 737 a share, they have negotiated for themselves, which includes a substantial control premium, and the current market quotations is yawning.

Avoidance of capital gains

What gravitates all these persons, essentially concluding a private deal, towards an avowedly public trading platform? The answer is avoidance of capital gains tax — according to the income-tax law long-term capital gains are completely exempt from tax if they are earned through a recognised stock exchange in India.

Ironically, the Government, which routinely brings in amendments to the income-tax law in successive budgets when tax avoidance comes to light, especially in the light of the helplessness pleaded by courts in reading the riot act, has not bestirred to close this escape route in the process fuelling the suspicion that it is afraid of upsetting the apple-carts of big-ticket investors who are invariably the beneficiaries of this rather mysterious trading platform.

The issue is: Should the Government offer a public trading platform meant to carry out open and transparent deals for consummating private deals, and facilitating tax avoidance?

Attention needed

The issue cries for immediate action for another reason. In any takeover deal, the public shareholders’ benefit from the huge negotiated price to a limited extent — only 20 per cent of the shares of the company are required to be offered to be bought from the public shareholders in addition to what is acquired on a negotiated deal.

But that cannot be their grievance because one understands that in any negotiated bulk deal, there is an element of control premium that forms a hefty portion of the offer price and such control premium is not obviously meant for public shareholders.

In the event, they should be content with whatever is offered to be bought from them. The sore point with them however is not this. What makes them bitter is the possible differential tax treatment —they invariably end up paying capital gains tax for the simple reason that they have not earned their gains through a recognised stock exchange in India.

And the promoters? Well they stand a chance of avoiding the tax if the market catches up with the negotiated price quickly enough. This potential discrimination turns the fundamental canon of taxation — tax accordingly to ability — on its head. And the blame for this discrimination can be easily laid at the doors of the stock exchange regulations that allow private deals through its portals.

(The author is a Delhi-based chartered accountant.)

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