Long-term cap gains googly to hit ESOPs, promoters, PEs

Chennai/Mumbai: A proposed amendment introduced in this Budget has sent promoters and employees who got shares under ESOP schemes and even private equity players in a tizzy. The reason: If the shares held were once unlisted but sold post an IPO, long-term capital gains (LTCG) benefit will not be available. There will be a tax incidence of 20% without indexation and 10% with indexation.
At present, LTCG arising on sale of shares held for more than a year does not attract any capital gains tax.
Only a minimal securities transaction tax (STT) of 0.1% is payable. However, this has been subject to misuse, and the Budget proposals seek to restrict the exemption to only those transactions where STT is paid both at the time of acquisition and sale. There is no STT payable on unlisted shares or off-market transactions.
The Budget proposals say that: Exemption under section 10(38) for income arising on sale of equity shares acquired after October 1, 2004 shall be available only if the acquisition of shares was chargeable to STT.
Girish Vanvari, tax head at KPMG India, says, “The intent of the proposal is to curb sham transactions undertaken on the stock market to convert black money into legitimate money in a tax-free manner. However, the proposed amendment will create issues in a number of genuine cases, such as where private equity players have acquired shares pre-listing and will exit on the open market post-listing, where promoters sell shares after an IPO, if shares were acquired via inheritance or mergers and demergers. It could also impact ESOP holders.” Several startups were planning an IPO in the near future, and promoters, investors and employees who exit post an IPO could face this tax challenge. Shubhankar Bhattacharya, venture partner, Kae Capital, says, “If the amendment seeks to tax gains made by early investors, it would discourage founders and investors to stay in the game for the long haul. Some of India’s most successful companies like Infosys or Justdial were all startups who graduated to an IPO at some point.”
Mahesh Parasuraman, co-founder and partner, Amicus Capital, says, “The real impact is on mid-market growth capital funds whose portfolio companies normally go in for an IPO. However, the government has left a window open exempting a certain category of investors from this amendment, such as acquisition by non-residents under the FDI route.”
Punit Shah, partner, Dhruva Advisors, adds, “Exemption is also available from these provisions in genuine cases where STT could not have been paid on acquisition like IPO, follow-on public offer (FPO), bonus or rights by a listed company. Plus, the government intends to notify other instances.”
As of now, anxieties remain. “One can also debate whether this proposal was required as GAAR will be a reality come April,” sums up Vanvari.
Concern over impact on ESOPs
Experts raised concerns on the impact on shares granted via employee stock options, a tool used by many startups today to attract and retain talent. If an employee after an IPO sells shares granted to him under ESOPs, he would face challenges of these proposals. However, MoF officials are seized of various genuine transactions where STT could not be paid on acquisition. The forthcoming clarification could exempt ESOPs.