Recently, the promoters of Ranbaxy struck a deal with Daiichi Sankyo of Japan for transfer of 34.81 per cent holdings for a consideration of Rs 9,576 crore at Rs 737 a share. However, the current market price of the share is hardly 40 per cent of the deal amount due to the financial crisis.
The promoters of Ranbaxy are residents of India and the subject matter of transfer, namely, shares in Indian company, which are proposed to be transferred to non-resident Daiichi of Japan. The taxability of the transaction is beyond doubt in this case in contrast to the Vodafone case.
In the Vodafone case, it involved two non-resident companies outside India engaged in purchase-sale of shares of a company in India.
Applying the source rule, it was contended that the transaction is liable for capital gains tax in India and the issue is still debated and not free from doubt.
The Ranbaxy case, however, does not involve such debates as regards its taxability.
Sale of shares in respect of mergers and acquisitions (M&A) requires tax planning to minimise the burden. In the case of transfer of shares by way of bulk deal routed through the stock exchange, it is liable for STT (Securities Transaction Tax) at 0.125 per cent plus service tax. For effecting bulk deal a minimum of 5 lakh shares or minimum value of Rs 500 lakh must be executed in a single transaction through the stock exchange.
Yet another option of divesting the shares is by means of off-market transactions, which would invite tax liability as Section 10(38) or Section 111-A will not apply.
Character of asset
To determine the tax liability in respect of sale of shares, its character whether long term or short term, has to be ascertained first. A share kept for less than 12 months is a short-term capital asset else it is a long-term capital asset.
If such long-term capital assets are transferred through stock exchange and STT is paid, the entire capital gain is exempt under Section 10(38) of the Act. If the transferor is a corporate entity, the long-term capital gain, though exempt under Section 10(38), will be included for the limited purpose of computing MAT.
If shares falling in the category of long-term capital asset are sold through off-market transaction, no STT would be payable and the long-term capital gain tax could not exceed 11.33 per cent of the capital gain computed without indexation.
Where the shares are held for less than 12 months and sold through a stock exchange, the capital gain (obviously without indexation benefit) would be taxed at 15 per cent plus surcharge and cess. The effective rate is 16.995 per cent.
If the shares held for less than 12 months are sold through off-market deals then the short-term capital gain would be taxed at the normal rate, which is 33.99 per cent (including surcharge and cess).
Scope for planning
Sale of shares listed in a stock exchange could be resorted to in the following manner to minimise tax liability.
Constitution of firm: A partnership firm consisting of the transferor and transferee may be constituted first and the shares could be contributed by the transferor by way of capital contribution and the transferee could bring cash or other liquid resources.
After a while the transferor may retire from the firm and the latter could continue to hold the shares. The amount recorded in the books of the firm at the time of contribution as capital is the deemed sale consideration for computing capital gains tax in the hands of the contributing partner.
Market value of the asset contributed could not be considered, as the provision contained in Section 45(3) is a deeming provision and it seeks only the value recorded in the books for computing the capital gains upon contribution.
Similarly, on retirement of a partner, no valuation or market value of assets need to be reckoned in law though the settlement to the retiring partner might be made based on such exercise. Any amount received by a retiring partner in excess to his capital balance is not liable to tax as held in CIT vs R. Raghukumar (247 ITR 801 SC). By this process, the firm could retain the ownership of shares of a company and the change of guard to the company is possible without any tax implication.
One-firm for each company: In the case of groups of companies managed by same persons or a group of families, a firm could be constituted for holding each company shares. When any company is to be sold, the promoters of the company having the firm as the medium for holding the shares may go in for reconstituting the firm by admitting the vendee first and retiring thereafter from the firm, and thus avoid tax liability.
Reverse merger: A company proposing to divest shares in another company, which might result in huge taxable capital gains, may go in for merger with a sick corporate having huge accumulated losses. The taxable capital gain by way of sale of shares whether long term or short term would be reduced or cushioned by the accumulated loss or depreciation of the sick company.