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This article is written by Rishabh Dasgupta pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.

Table of Contents

Introduction

The term mergers and acquisitions (“M&A”), for the purpose of basic understanding, is a phrase commonly used with respect to inorganic corporate growth and expansion of a company which either involves taking over a target company or a specific business undertaking of the target company, (“acquisition”) or the consolidation of the companies (“merger”).

Acquiring a company or its business undertaking can be done by a company in five ways namely – (a) asset sale, (b) slump sale, (c) share sale, (d) amalgamation and (e) demerger. The mode of acquisition sought by a company can have wide-ranging implications for both the acquirer and the seller which primarily includes but is not limited to taxation, stamp duty, successors liability, employee transfer, a bundle of other commercial considerations and the time and energy invested by the parties in structuring the transaction and getting the deal done. Thus, the transaction structure if not chosen correctly and wisely could simply sabotage and break the deal especially, in a country like India. 

This article aims at specifically discussing the concept of a company acquisition via share sale along with its tax and stamp duty implications in India.

Company acquisition via the sale of shares

Shares reflect the complete underlying value of the assets and liabilities of the company. An acquiring company opts for a share-sale acquisition if they are looking to secure the company as well as the business setup. This usually happens when the target company has created a name for itself and has significant goodwill and a customer base in the market.

For the purposes of understanding, it is pertinent to note at this juncture that an acquiring company usually has a choice between acquiring – (i) the entire company which may have one or more businesses undertakings under its name or (ii) a specific business undertaking wherein the acquisition is not of the ‘target company’ but instead, that of the particular ‘business undertaking’ of the target company. 

As per Section 2(19AA) of the Income Tax Act, 1961, the term “undertaking” includes – (a) any part of an undertaking, or (b) a unit or division of an undertaking or (c) a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.

For example: 

Company X has two (2) business undertakings wherein its division XA is into the retail business of electronic gadgets and appliances while another division XB is into the retail business of clothing and fashion accessories.

Now, company Y wants to enter into the business of gadgets and appliances and solely wants to acquire the division XA of company X. In this scenario, company Y should not opt for a share acquisition since this would lead to the buying of the entire company X including all its assets and liabilities.  Instead, company Y would proceed with a slump sale transaction or a court-approved demerger which would cater to the objective of company Y to selectively own or control division XA, as a going concern, and not the entire company X.

Tax implications

The tax has always been a key factor governing the transaction structure of an M&A in India. The major tax implications on share acquisitions are: 

  1. Tax liability on capital gains, if any, and 
  2. Tax liability on income from other sources, if any.

Capital gains: Section 45 of the Income Tax Act, 1961

What are capital assets and capital gains?

Capital assets

  1. For a basic understanding, capital asset means anything of value which an individual might possess such as home, car, jewellery etc. and which can be sold and monetized. For businesses, it is an asset with life usually longer than a year and which is not intended for sale in the regular and ordinary course of the business operation.
  2. For the purposes of taxation, Section 2(14) of the IT Act defines a ‘capital asset’ as a property of any kind held by an assessee, whether or not connected with his business or profession, or any securities held by a foreign institutional investor but does not include:
  • Any raw materials, consumable stores or stock-in-trade held for the purposes of profession or business; and
  • Personal valuables i.e., movable property (including wearing apparel and furniture) held for personal use by the assessee or any member of his family dependant on him, but excludes— (a) jewellery; (b) archaeological collections; (c) drawings; (d) paintings; (e) sculptures; or (f) any work of art.

Capital gains

  1. Any profits or gains which an assessee gained with respect to the transfer of his capital asset in the preceding year shall be chargeable to the income-tax under the head “capital gains”, and shall be deemed to be the income of the preceding year in which the transfer took place subject to the exceptions provided in Section 45 of the IT Act, 1961.
  2. For the purposes of taxation, capital gains are further divided into short-term capital gains and long-term capital gains.
  3. The requisites to determining the tax rate on shares depend on the following three (3) factors:
  • Whether the target entity is a public listed/unlisted company or a private company;
  • Whether the sale of shares took place in a recognized stock exchange or by way of a private arrangement; and
  • Whether the seller is a resident or a non-resident shareholder.

Short-term capital gains

Parameter

Relevant Section under IT Act, 1961

Short term capital gain

Tax

Rate of tax

 

 

 

 

Resident Shareholder

Non-Resident Shareholder

Time Duration of Asset

Section 2(42A)

Assets held for less than thirty-six (36) months.

Tax rates shall be applicable based on the categorisation of assets under the IT Act, 1961.

Section 2(42A) Proviso 1

Listed equity shares held for Less than twelve (12) months.

Sale of Listed equity shares on the floor of
Recognized Stock Exchange

15.00%

15.00%

Section S2(42A) Proviso 3

Unlisted equity shares held for less than twenty-four (24) months.

Sale of unlisted equity shares

30.00%

40.00%

Computation of Short-Term Capital Gains

Section 48

Short term capital gains = Sale Consideration – (Cost of Acquisition / Improvement) – (Expenditure incurred on Asset)

Long-term capital gains

Parameter

Relevant Section under IT Act, 1961

Long term capital gain

Tax

Rate of tax

 

 

 

 

Resident Shareholder

Non-Resident Shareholder

Time Duration of Asset

Section 2(29A) r/w Section 2(42A)

More than thirty-six (36) months for regular assets.

Tax rates shall be applicable basis the nature of the asset and the tax head they’ll fall under the IT Act, 1961.

Section 2(29A) r/w Section S2(42A)

More than twelve (12) months for listed shares.

Listed equity shares on the floor of
recognized stock exchange

20% with indexation
benefit or 10% without
indexation benefit

10% without indexation benefit or foreign exchange fluctuation benefit

Section 2(29A) r/w Section S(42A)

More than twenty-four (24) months for unlisted equity shares.

Sale of unlisted equity shares

20% with
indexation benefit;
or 10% without
indexation benefit

10% without indexation
benefit or foreign exchange
fluctuations benefit.

Computation of Long-Term Capital Gains

Section 48 

Long term capital gains = Sale Consideration – (Indexed Cost of Acquisition / Improvement) – (Expenditure Incurred on Asset)

Computations of Indexed Cost of Acquisition 

(I-COA) 

 

I-COA = COA × Cost Inflation Index (CII) of Year of transfer of Capital Asset by Seller ÷ CII of the Year of Acquisition of Capital Asset by the Seller

For the avoidance of doubt and purposes of clarification

  1. Sales Consideration” means the purchase price offered by the buyer to the seller for the sale of a capital asset.
  2. Cost of Acquisition” means the price at which the seller had purchased the capital asset.
  3. Indexation” helps to incorporate the time value of money with the adjustment of inflation factor to ensure the computation of long-term capital gains.
  4. Expenditure incurred on Assets may include costs such as securities transaction tax, brokerage charges, health and education cess etc. with respect to the sale of shares.

Income from other sources: Section 56 of Income Tax Act, 1961

  1. Section 56(2)(x) of the IT Act, 1961 states that in the event, any person/entity receives any property, other than immovable property, including shares of a company, without consideration, or for a consideration which is less than the fair market value (“FMV”) of the movable property, which is calculated as per Rule 11(UA) of the Income Tax Rules, 1962, by an amount exceeding fifty thousand rupees (INR 50,000) – such difference between the FMV and the consideration received by the person / entity shall be taxable, in the hands of the recipient, under head ‘income from other sources’ subject to the certain exception provided in Section 56(2)(x)(c) of the IT Act, 1961.
  2. The tax rate applicable shall depend on the tax status of the person/entity:
  • Individual: Taxable at the applicable slab rate for such individual; 
  • Domestic Corporates: Corporate tax rate ranging from 15% to 30% as applicable;
  • Indian firm: 30%; and 
  • Foreign company: 40%.

Categorisation of shares as capital assets or stock-in-trade

For the purposes of taxation of income, shares can be either held as a capital asset or as a stock-in-trade. The term stock-in-trade has not been defined under the Income Tax Act, 1961. However, the term can be literally interpreted as shares being used in the ordinary course of business for gaining profits compared to a capital asset which is usually held for a period longer than a year and is not intended for sale in the regular and ordinary course of the business operations.

The shares treated as ‘stock-in-trade’ are taxed as business income under the head of ‘profit and gains from business and profession’ while the shares treated as capital assets will fall under the head of ‘capital gains’ for the purposes of computation of tax by the income tax authorities.

  • Sale of listed shares/securities

The Central Board of Direct Taxes (“CBDT”) vide it is Circular No. 6/2016 laid down the following principles with respect to the characterization of income that arises from the sale of listed securities:

  1. An assessee who has listed shares held for more than twelve (12) months, also has the similar option to treat the shares either as a long-term capital asset or stock-in-trade. However, this stand, once chosen by the assessee for a particular assessment year, shall remain applicable in the rest of the subsequent assessment years and shall not be allowed to adopt a different/contrary stand in the subsequent assessment years.
  2. There are no clear or express guidelines under the circular for the determination of listed shares, held for a period less than twelve (12) months, as business income or capital gains and may be determined based on the facts of each case. However, if Para 3(a) of the circular is referred, it may be inferred that an assessee who has listed shares held for less than twelve (12) months, has the option to treat the shares either as a stock-in-trade or a short-term capital asset and has the liberty to opt either of the two categorizations each assessment year for the purposes of taxation. The following points should be taken into consideration which classifying these shares as business income or capital gains:
  1. Whether the purchase/ sale of securities was allied/incidental to his usual trade or business or it was an occasional activity;
  2. Whether the purchase was made solely with the intention of resale at a profit or for long term appreciation and/or earning dividends and interest;
  3. Whether the scale of activity is substantial; 
  4. Whether such transaction was entered into continuously and regularly during the assessment year; and
  5. Time devoted to the activity and the extent to which it is the means of a livelihood.
  • Sale of unlisted shares/securities

  1. The CBDT vide its Order F. No. 225/12/2016/ITA.II held that unlisted shares held by an assessee shall be treated as capital gains regardless of the holding period of such shares by the assessee.
  2. However, vide CBDT letter F. No. 225/12/2016/ITA.II dated 2nd May, 2016, it was clarified that the above assumption may not be necessarily applicable to cases wherein:
  1. The genuineness of the transactions concerning the sale of such unlisted shares is questionable; or
  2. The transfer is related to an issue pertaining to the lifting of the corporate veil; or
  3. The transfer of unlisted shares is made along with the control and management of the underlying business. It has been clarified that this particular exception won’t be applicable in the case of transfer of unlisted shares by SEBI registered Category-I and Category-II Alternative Investment Funds.

What is known as stamp duty?

  1. Earlier, the state government had the power to levy stamp duty on the transfer of shares and the issue of share certificates but since the amendments made to the Finance Act, 2019 which came into effect on 1st July 2020, all the financial transactions will be chargeable with a uniform rate of stamp duty.
  2. As per the amendment made by the Finance Act, 2019, the rate of stamp duty on transfer of shares is now made uniform across the country and capped at 0.015% on the value of shares transferred and 0.005% on the issue of share certificates.
  3. Earlier, no stamp duty was levied in case the shares were held in an electronic (dematerialized) form with a depository (and not in a physical form). However, the Finance Act, 2019 also amended to limit such exemption to transfer of securities from a person to a depository or from a depository to a beneficial owner.

Particulars

Before Amendment

After Amendment

Issue of Share Certificates

Varies from state to state

0.005% for all states

Transfer of Shares in physical form

0.25%

0.0015%

Transfer of Shares in dematerialised form

0%

0.0015%

Key takeaways

  • Shares reflect the complete underlying value of the assets and liabilities of the company.
  • Acquisition through the sale of shares means the acquisition of the company and its business along with all its assets and liabilities.
  • A company acquisition via the sale of shares would attract capital gains tax under Section 45 and will be calculated as per the provisions of Section 48 of the Income Tax Act, 1961.
  • Capital gains tax levied will depend upon the time duration of holding these assets by a company basis which will be categorised as a short-term capital asset or long-term-capital asset. 
  • Listed equity shares held for more than 12 months or unlisted equity shares held for more than 24 months will be categorised as long-term capital assets and attract a capital gains tax rate of 20% (including indexation benefit and excluding surcharge/cess). 
  • Listed equity shares held for less than 12 months and unlisted equity shares held for less than 24 months will be categorised as short-term capital assets and attract a capital gains tax rate of 15% for listed equity shares and 30% for unlisted equity shares (excluding surcharge/cess). 
  • Short term capital gains = Sale Consideration – (Cost of Acquisition / Improvement) – (Expenditure incurred on Asset).
  • Long term capital gains = Sale Consideration – (Indexed Cost of Acquisition / Improvement) – (Expenditure Incurred on Asset). Shares can be either held as a capital asset or as a stock-in-trade of a company. The shares treated as ‘stock-in-trade’ are taxed as business income under the head of ‘profit and gains from business and profession’ while the shares treated as capital assets will fall under the head of ‘capital gains’ for the purposes of computation of tax by the income tax authorities.
  • The rate of stamp duty on transfer of shares has been made uniform across the country and capped at 0.015% on the value of shares transferred and 0.005% on the issue of share certificates.

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