Tax treatment proposal on unlisted shares to affect investors of private firms

India proposes to redefine the capital gains tax treatment of unlisted shares, bringing in a distinction with the treatment on listed shares.

This move — having a distinct capital gains tax treatment for unlisted shares — could affect investors and shareholders of private companies and possibly hinder private equity activity in India, say tax experts.

Short-term capital asset Budget 2014-15 proposes to provide that an unlisted share will be considered a “short-term capital asset” if held for not more than 36 months. This is in variance with the existing position in income tax law that an unlisted share held for ‘not more than 12 months’ is considered a ‘short-term capital asset’.

The proposed change in the holding period norm for unlisted shares to qualify as short-term capital asset could put investors in a bind in terms of post-tax returns, say tax experts.

“The proposal to increase the holding period for unlisted shares to qualify as short-term capital asset to 36 months from 12 months is regressive and may have unintended consequences. This is because short-term capital gains are subject to tax at a normal rate of 30 per cent,” said Aseem Chawla, Partner, MPC Legal, a law firm.

Intention and amendment Seemingly, the intention (of the Government) was to amend the capital gains tax treatment of debt-oriented mutual funds.

However, the amendment encapsulates unlisted shares also, Chawla said, adding that this will impact shareholders and investors of private companies.

Dinesh Kanabar, Deputy CEO of KPMG in India, said India had always held shares whether listed or unlisted on par (as regards tax treatment).

“There is no need to distinguish because it is a method of funding.

“Listing does not give you any advantage or disadvantage and, therefore, this new proposition that unlisted shares have to be held for three years is not warranted,” Kanabar told BusinessLine here.

The proposed change of law to say that short-term capital gains will arise in respect of transfer of unlisted shares if they are not held for three years needs to be reviewed, Kanabar said.

The proposal could affect private equity activity as such investments are usually long-term. “But there are times when people need to exit. Not having that opportunity is a problem,” Kanabar said.

Holding period itch Former CA Institute Secretary Ashok Haldia said investors normally do not feel comfortable with a three-year holding period. “They would like to keep their options open.”

Also, those entrepreneurs looking for short-term capital arrangements through buy-back mode will find it difficult to get investors, Haldia said.

One important fallout of the latest proposal could be that foreign private equity investors pumping money into India could start looking at post-tax returns.

They could look at returns that offset the loss of revenues due to higher tax burden.

But domestic lending institutions may cheer the proposed amendment as it would increase their comfort over the investors staying invested with the enterprise for a longer term.

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