Higher LTCG Tax for Those Betting on Mergers

LACUNAE Grandfathering benefit for taxes on longterm capital gains doesn’t cover mergers, demergers

Investors of at least two dozen companies, including Capital First, Ultra Tech Cement, Bharat Financial, will have to shell out higher capital gains tax. This is because the ‘grandfathering’ benefit for taxes on longterm capital gains — reintroduced in this year’s Union Budget — doesn’t cover mergers and demergers. Grandfathering refers to exemptions on the gains made prior to enactment of a new law from the ambit of the new law. The government said longterm capital gains tax will be calculated based on the Jan 31 trading price of a stock. However, this benefit applies only to stocks acquired or purchased before Jan 31, 2018. If the shares were non-existent or unlisted as on Jan 31 long-term capital gains tax would be calculated based on original cost of purchase.

In mergers, investors of the company getting acquired receive shares of the new company in exchange for their original shares. Such shares would be considered as acquired after Jan 31. As a result, long-term capital tax would be calculated based on original cost of acquisition. “In cases where a company merges with another company after February 1, 2018, grandfathering provisions do not apply and the taxpayers of amalgamating company will have to pay capital gains tax on entire gains computed with reference to original cost basis,” said Bhavin Shah, partner, PWC India.

For instance, consider the ongoing merger of IDFC Bank and Capital First. Assume a shareholder ‘A’ had purchased 10 shares of Capital First in 2011 and is still holding the stock. The companies have agreed to a swap ratio of 139:10. Hence, the shareholder ‘A’ will get 139 shares of IDFC Bank in exchange for his 10 Capital First shares. Since these 139 shares ‘A’ gets were created after Jan 31, the grandfathering benefit will not apply. Hence, when ‘A’ decides to sell his IDFC Bank shares in future, the cost of acquisition will be the price at which he purchased the shares back in 2011. The tax outgo would be at least 5-6 times higher in this case since Capital First shares have gained nearly 300% since 2011. Had there been a grandfathering exemption on these deals, ‘A’ would have to pay tax only on the gains made after January 31.

As per latest rules, selling of any stock held for less than a year will be subject to short-term capital gains tax while the ones held more than a year are subject to long-term capital gains tax. Short-term capital gains tax on stocks and equity mutual funds is charged at a rate of 15% while it is 10% for the long-term. The rules are different for the acquiring company. In the earlier scenario, if ‘A’ had purchased IDFC Bank shares in 2011 and sold them now, he wouldn’t be needed to pay tax on gains made before January 31.

The Economic Times,09th October 2018