Taxation of unlisted shares

Summary

Unlisted shares are generally taxed based on the duration of holding. If held for less than 24 months, the seller will be taxed based on their income tax slab. For longer holding times, the taxation rate varies based on the type of holder (individual, HUF, company, etc.).

1. Period of holding

This refers to the time span for which an unlisted stock is held by you. Period of holding is computed from the date on which the stock was acquired until the date of its sale.

(In case the stock is acquired through inheritance, gift or transfer, the period of holding shall be decided as per various other provisions of the Income Tax Act).

An unlisted equity share is considered a long-term capital asset if it is held for more than 24 months.

If held for 24 months or less, it will be considered a short-term capital asset and taxed accordingly.

2. Tax on long term capital gains

The tax payable on long-term gains (LTCG) is treated as follows:

• In case of an Indian individual or HUF - 20% of LTCG after indexation benefit.
• In case of a domestic company - 20% of LTCG after indexation benefit*.
• In case of a non-resident or a foreign company - 10% of LTCG without indexation benefit and without applying the first provision to Section 48. i.e. In case of an non-resident, capital gains arising from transfer of shares or debentures in an Indian company, shall be computed by converting the cost, transfer expenses and sale consideration into the same foreign currency as was initially utilised in the purchase of the asset. The capital gains computed shall be reconverted to Indian currency.
• In case of any other resident - 20% of LTCG after indexation benefit.

*Indexation is a method used to determine the value of an asset after taking inflation into account. When computing tax, indexation reduces one's tax liability.

3. Tax on short-term capital gains

Short-term gains (STCG) arising from sale of unlisted shares shall be taxable at the normal slab rates applicable to you.

For individuals below the age of 60, the tax slabs are as follows -

For income of up to ₹2,50,000 - Nil

For income of ₹2,50,001 to ₹5,00,000 - 5%

For income of ₹5,00,001 to ₹10,00,000 - ₹12,500 + 20% of total income exceeding ₹5,00,000

For income above ₹10,00,000 - ₹1,12,500 + 30% of total income exceeding ₹10,00,000

Note: These rates do not include surcharge and cess.

4. Exceptional cases

As per Section 10(38): Capital gains arising from sale of a long-term capital asset being equity share in a company or unit of an equity-oriented mutual fund or unit of a business trust shall be exempt from tax provided such transaction is chargeable to securities transaction tax.

Section 111A: Capital gains arising from sale of a short-term capital asset being equity share in a company or unit of an equity-oriented mutual fund or unit of a business trust shall be chargeable to tax at the rate of fifteen percent provided such transaction is chargeable to Securities Transaction Tax.

These sections will apply only if all the following conditions are fulfilled:

• The gains arise from sale of a capital asset
• The asset is a long-term capital asset
• Such transaction is chargeable to Securities Transaction Tax (STT). Exemption is available if such sale transaction takes place on a recognised stock exchange.

Consider a case where unlisted equity shares are sold by the holder of such shares under an offer for sale to the public included in an Initial Public Offer (IPO) and such shares are subsequently listed on a recognised stock exchange.

STT is chargeable on such sale and thus, if such shares were long-term capital assets.

• As per section 10(38), the Long-Term Capital Gains on above sale shall be exempt.
• As per 111A, the Short-Term Capital Gains on the above sale shall be taxable at 15%.

Here's an example.

Balance Sheet of a company whose shares you own:

The company comes out with a public issue of 25 crores shares at an issue price of ₹40 (₹30 + ₹10 premium), the terms of issue are:

• Fresh issue of 15 crore shares @ ₹40 each
• In the public offer, promoters will offer their 10 crore shares to the public @ ₹40 each and these 10 crores shares will form part of the public share. After the public issue, all 75 crores shares will be listed on the stock exchange.

STT will be chargeable as unlisted equity shares are sold by the promoters of such shares under an offer for sale to the public included in an Initial Public Offer (IPO) and such shares are subsequently listed on a stock exchange.

Note: Loss from sale of shares - As section 10(38) exempts any income arising from transfer of the above mentioned unlisted shares, a loss arising on sale of such shares, satisfying the conditions of section 10(38), is not eligible for set off against taxable gains under section 70 or carry forward and set off under section 74. Such loss is a dead loss and shall have no tax treatment.

5. Tax on issue of shares at more than fair value

Where a closely held company issues its shares at a price which is more than its fair market value then the amount received in excess of fair market value of shares will be charged to tax in the hand of the company as income from other sources.

This clause is applicable when:

• Shares are issued by a closely held company.
• Amount is received from a resident only.
• Issue price is in excess of Fair market value of shares.

This clause is not applicable in the following situations:

• Issue of shares by widely held companies like public companies having large no. of shareholder in public is interested.
• Receipt of share application money from non-resident applicants.
• Issue price exceeding fair market value of shares but not exceeding face value of shares.
• Consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.
• Consideration for issue of shares is received by a company from a class or classes of persons as may be notified by the central government in this behalf (till date no such person has been notified by the central government).

What is a closely held company?

A closely held company is one in which the public are 'not' substantially interested.

In general, majority shares in such companies are held by a small group of shareholders and are not open to outsiders. Such groups of shareholders can also be family members.

How to determine the fair market value of shares?

Fair market value of shares shall be the higher of:

• Fair market value of shares calculated in accordance with such method as may be prescribed (in Income Tax Rules).
• As substantiated by the company to the satisfaction of an assessing officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature.

References:

The Income Tax Act, 1961

Income from Capital Gains and Other Sources Module by CA. Vinod Gupta