New Delhi, January 26, 2017

Income from sale of unlisted shares to be treated as ‘capital gains’

Call this the CBDT’s Republic Day gift to the venture capital (VC) and private equity (PE) industry that is betting big on Indian start-ups.

The Central Board of Direct Taxes (CBDT) has sweetened the deal for certain VC and PE funds investing in start-ups, encouraging such funds to invest more with a promised beneficial tax treatment of their future gains from transfer of shares.

It has now ruled that profits made by SEBI registered Category I and II Alternate Investment Funds (AIFs) from stake-sales in start-ups will be treated as “capital gains” for income-tax purposes, even if such sales were to result in transfer of control and management of the underlying business.

Prior to this, any income arising to a PE or VC from stake-sales in start-ups and involving the transfer of control or management change was to be treated as “business income”.
Lower tax rate

Treating the income as “capital gains” is more beneficial for PE/VC funds as it attracts a lower tax rate.

The latest CBDT move — which has come in the form of a letter to its field formations — has sought to alter its May 2016 order that had clarified the position regarding tax treatment of income arising from transfer of unlisted shares.

In the May 2016 order, CBDT had said that income from such a transfer would be taxable as ‘capital gains’, irrespective of the period of holding of the unlisted shares. There were, however, certain exceptions rigours prescribed, including the case of transfer of control or management change.

Put simply, as per an exception rigour, the CBDT had then said income arising to a VC/PE fund on stake-sale of unlisted shares of ventures, many of which are new set-ups or start-ups, would be treated as “business income” if the deal involved transfer of control or management change of the underlying business.
Experts’ take

Abhishek Goenka, Partner, Tax & Regulatory Services, PwC, said the latest CBDT move will bring much needed clarity and relief to AIFs, since — as has been mentioned in the clarification — some sort of control is inherent in most deals.

At the same time, the issue remains open for other investors, and also for promoters doing strategic exits, Goenka added.

Pranay Bhatia, Partner-Direct Tax, BDO India, said: “Though the clarification is helpful for AIF Category I and II, the long-only Category III funds still suffer taxation on sale of shares as business income, as against capital gains”.

Amit Maheshwari, Partner, Ashok Maheshwary & Associates LLP, a CA firm, said typically angel, venture capital and PE investors who are registered as AIF1 and AIF2 funds have control and management in investee companies in some form to protect their investment.

“Taking these cases out of exception is a welcome move to avoid any ambiguity in classification of gains derived from sales of unlisted shares,” he said.

[The Hindu Business Line]