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Tax outgo may rise for investors in companies undergoing M&A cases
February, 13th 2018

Investors in companies undergoing mergers and acquisitions (M&A) may have to pay a higher tax outgo as they may not be able to avail grandfathering benefit in the long-term capital gains (LTCG) tax, according to a report in Business Standard.

On February 1, Finance Minister Arun Jaitley had presented the new provisions of LTCG tax in his 2018-19 Union Budget speech. The Finance Minister said that the government would tax long-term capital gains exceeding Rs 1 lakh at a rate of 10 percent without giving any indexation benefits.

However, FM Jaitley added that all gains up to January 31, 2018 will be 'grandfathered'.

Also Read — Budget 2018: What does grandfathering mean?

Under the previous laws, the cost of shares of the amalgamating listed company could be carried over as cost of shares of an amalgamated listed company.

Section 49 of the Income Tax Act allows carrying-over of the cost of original shares for the new asset that emerged as a result of a corporate action such as merger, demerger or consolidation of a listed company. However, the provisions under this law do not allow grandfathering.

The Central Board of Direct Taxes (CBDT) is yet to issue any clarifications on this regard. It could mean that the tax liability to the seller would be calculated on gains after deducting the original acquisition cost for shares as against the deemed cost step-up or the grandfathering cost.

Also Read — Budget 2018: Here’s how LTCG tax regime will work in equity-related investments

“While the law provides for tax neutrality for merger, demerger, stock split and consolidation transactions by allowing carry-over of the original cost to the new asset, the revised law levying 10 per cent LTCG tax does not provide for grandfathering or cost step-up as on January 31, 2018, for such transactions,” Bhavin Shah, leader, financial services tax, PwC India, told the newspaper.

Rajesh Gandhi, partner at Deloitte Haskins & Sells, told the newspaper that it is unlikely for CBDT to allow the January 31 grandfathering benefit for shares received pursuant to corporate actions like mergers and demergers. This may result in a significant tax outgo.

“Technically, the grandfathering benefit will not be available if the shares are listed after January 31 because of how the term ‘fair market value’ is defined. This is of particular concern to private equity funds,” Gandhi said.

According to the report, the grandfathering clause will not be applicable even if a listed company merges with an unlisted one, as one may not find fair market value reference provided for in the rules for an unlisted entity as on January 31, 2018.

Also Read — Imposition of LTCG tax: Does it make ULIPs a better investment bet than equity mutual funds?

“The proposed Section 112A to be introduced calls for grandfathering of cost only for listed shares. The unlisted shares do not require any such grandfathering as they are already being taxed.,"Amit Maheshwari, partner, Ashok Maheshwary and Associates told the newspaper.

Maheshwari further added that definition of ‘fair market value’ under this section (112A) includes within its ambit only the listed shares and units of equity-oriented funds.

"However, where an unlisted company is merged with listed shares, it needs to be clarified how the gains on sale of shares thereafter of the new company will be taxed," Maheshwari said.

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