Share Swap Capital Gains Tax between listed and unlisted Indian companies

• When is Tax Payable?

  • Tax liability arises at the time of the swap (transfer event), not when listed company shares are sold later.

• Tax Calculation for Pvt. Ltd. Shareholders:

  • Capital Gains = FMV of listed company shares received - Cost of acquisition.
  • Cost of acquisition = Higher of ₹83L (original capital) or ₹1.5cr (book value).
  • Gains are taxed:

    • 
      LTCG (if held >24 months): 20% with indexation.
    • 
      STCG (if held ≤24 months): Taxable at slab rate.

• Valuation Rules for Listed Company:

  • Listed company cannot arbitrarily set valuation at ₹50cr. FMV must follow SEBI guidelines (based on market cap).

• Regulatory Compliance:

  • Proper valuation reports for both companies are mandatory under SEBI and Companies Act to validate the swap ratio.

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Please find below answers

a) In the given case in the hands of owner of private limited shares taxability will trigger at the time of swap transaction takes place. Tax liability shall fall under capital gain - long term / short tern subject to their holding period in private limited company

b)

i) Valuation under 11UA need to work out for the listed company under income tax act and for the purpose of companies act listed value need to consider after giving effect of peer companies and market premium position as issued by registered value. As per my understanding it is difficult to get the valuation of 50 Crore with company having market cap of 250 Crore, however it will depends upon the balancesheet of the listed company, but in either case merchant banker report on valuation of shares will play key role since its mandatory requirement

ii) so effectively private limited company shareholder shall pay tax on sales value (5Cr / 25Cr - Depends upon final valuation report) Less Purchase cost of share i.e. Rs. 10 Per share and difference shall be subject to STCG or LTCG

Section 47(iv) & (v) shall not apply in given case since holding and subsidiary relation do not exist at the time of transaction execution, that relationship will arise only once this transaction is executed so you can fall under this section for future transactions only

However there can be better way to route this transaction to nullify or defer tax liability making sure there is no effective tax implication in the hands of private company shareholder through route of CCPS

Question 1: Tax Implications of the Swap Transfer

Scenario:

• Shareholders of the private limited company are offered a 10% stake in the listed company in exchange for 100% ownership of the private limited company.

Taxation for Shareholders of the Private Limited Company:

• The swap of shares is considered a "transfer" under Section 2(47) of the Income Tax Act, 1961, and is taxable under capital gains provisions.
• However, as per Section 47(vii), if shares are exchanged in a scheme of amalgamation or reorganization, the transfer may not be taxable at the time of the swap.

When Tax Becomes Payable:

1. At the Time of Swap:

   • If the transaction qualifies under Section 47, no tax is payable at the time of the swap. The capital gains will be deferred until the shareholders sell the listed company’s shares in the future.
   • If the transaction does not qualify under Section 47 (e.g., if it doesn’t meet the conditions for tax-neutral amalgamations), the gain is taxable in the year of the swap.

2. At the Time of Selling the Listed Company Shares:

   • When shareholders of the private company sell the shares of the listed company in the future, the capital gains tax will apply based on the sale consideration and the cost of acquisition (determined as per the swap value).
   • The holding period for determining short-term or long-term gains will start from the date the listed company’s shares are allotted.

Question 2: Valuation and Tax Implications

A. Can the Listed Company Reduce Its Valuation for the Swap?

• A listed company cannot arbitrarily bring down its valuation to ₹50 crore when its market cap is ₹250 crore. Valuation must adhere to the following:

  1. 
     Fair Market Value (FMV): The valuation should align with SEBI (Substantial Acquisition of Shares and Takeovers) Regulations or other valuation norms mandated for listed companies.
  2. 
     Independent Valuation Report: For such transactions, independent valuation reports are required to establish a fair exchange ratio.

If the listed company undervalues its shares, it could attract scrutiny from SEBI and tax authorities for compliance breaches.

B. Tax Implications for Private Company Shareholders
Taxable Gain:

• The gain will be determined as the difference between the FMV of the listed company shares received and the cost of acquisition of the private company shares.

1. Cost of Acquisition:

   • If the book value is ₹18/share, the total cost of acquisition for 8.3 lakh shares is ₹1.5 crore (₹18 x 8.3L).

2. FMV of Shares Received:

   • If the listed company issues ₹5 crore worth of shares, this becomes the deemed sale consideration.

Tax Calculation:

• 
  Capital Gain = Sale Consideration - Cost of Acquisition

  • 
    Case 1: ₹5 crore - ₹83 lakh (paid-up capital only)
  • 
    Case 2: ₹5 crore - ₹1.5 crore (book value, including reserves)

The applicable cost will likely be ₹1.5 crore, considering book value, but further clarity is needed based on transaction terms.

Applicable Tax Rate:

• If shares of the private company are held for more than 24 months:

  • 
    Long-Term Capital Gains (LTCG): Taxed at 20% with indexation benefits.

• If shares are held for 24 months or less:

  • 
    Short-Term Capital Gains (STCG): Taxed at the applicable income tax slab rates.

The 12.5% tax rate is not applicable here—it likely refers to concessional rates for certain specified assets under older provisions.

Final Advice on Tax Implications and Compliance Norms

1. Valuation Standards:

   • The listed company must adhere to valuation norms, ensuring the swap ratio is based on FMV. Arbitrary undervaluation is not permissible.

2. Tax on Shareholders:

   • If the swap qualifies under Section 47, there is no tax liability at the time of the swap, but shareholders will pay tax when selling the listed company’s shares.
   • If it doesn’t qualify under Section 47, shareholders will pay capital gains tax in the year of the swap based on FMV.

3. Consult Professionals:

   • Engage a Chartered Accountant or legal advisor to ensure compliance with SEBI, FEMA (if applicable), and tax regulations.

Let me know if you need further clarification or assistance with specific calculations or drafting agreements for this transaction!