Genuine equity investments through initial public offers and bonus share issues won’t have to face long-term capital gains tax even if no securities transaction tax (STT) was paid on their transfers. The Central Board of Direct Taxes issued a draft notification to this effect on Monday, bringing relief to the investment community.

It, however, failed to address a key concern related to off-market transactions in strategic purchases becoming taxable under the provision. Experts say the clarification also does not address concerns of capital gains tax being levied on employee stock options or gifts in the form of shares. The apex direct taxes body is seeking public comments on the notification clarifying the scope of a provision introduced in the budget this year to prevent tax abuse.

The notification lists three types of transactions where the provision will apply, while sparing genuine ones. The first is investment in listed stocks that are not traded frequently and the acquisition of equity through preferential issues not falling under the Securities and Exchange Board of India (Sebi) issue of capital and disclosure norms.

Second, those transactions where listed stock is not purchased over the exchange. Third, acquisition of shares in a company that's delisted and then listed again.

CBDT proposes norms for tax benefits for genuine equity deals

Tax experts said the notification has addressed some concerns over the amendment related to section 10(38). But they pointed that the second clause poses risks to genuine investors.

"This is an excellent notification by the government keeping in view the objective behind amendment to Section 10(38), which was to address cases of non-genuine, long-term capital gains being claimed as exempt from tax," said Sanjay Sanghvi, partner, Khaitan & Co.

However, while the cases covered in the draft notification seek to address the issue of bogus and "non-genuine" cases, it should specifically exempt genuine instances such as private equity investments, employee stock options etc., Sanghvi said.

In order to curb the practice of declaring unaccounted income as exempt from long-term capital gains by entering into sham transactions, the Finance Act, 2017 amended the provisions of Section 10 (38) of the Act. This meant exemptions under this section for income arising from the transfer of equity shares acquired on or after October 1, 2004, would only be available if the acquisition was chargeable to STT.

However, to protect exemptions for genuine cases where STT could not have been paid, it was provided that the government would notify instances when the provision would not apply. These include share purchases in IPOs, bonus or rights issues by a listed company, stock purchases by non-resident Indians in accordance with the foreign direct investment (FDI) policy etc.

But experts said that the second provision cited above may need another look.

"This means that if an investor purchases shares of a listed company off market, he will not be able to claim capital gains tax exemption on sale of such shares even if the shares are sold on the stock market," said Rajesh Gandhi, partner, Deloitte Haskins & Sells LLP.

He said this will have significant implications for all types of investors, specially private equity investors and strategic investors, which generally purchase a large quantity of listed company shares outside the stock exchange and could adversely impact the financial modeling and returns of such investors.

"Allaying many concerns, as per the draft clarifications, most genuine transactions will continue to be exempt from tax, including mergers and demergers, gifts, etc.," said Abhishek Goenka, leader, direct taxes, PwC. "The category related to purchases off the stock exchange is too wide and could cover several genuine cases."

However, a senior CBDT official told ET that genuine transactions won’t be taxed. "Genuine transactions like esops, bonus issues etc will not be touched," the official said.