Corporates face new tax hurdle

New Provision May Bring Rights Issues, Preferential Allotments Into Tax Net

COMPANIES going in for rights offering, share sale to a strategic investor or stock rejig among group firms may face new hurdles if taxmen choose to strictly interpret the law. 

    According to the tax code, individuals and companies receiving securities at a price less than the 'fair value' of the stock will be asked to pay tax on the difference. Tax experts fear that the income tax department may extend this rule to bring transactions like rights issue, preferential allotment to financial investor or JV partner, and transfer of holding to another group subsidiary under the tax net. 
    "Such a possibility cannot be ruled out if one does a literal reading of the provision, even though the intent is different... I feel that intra-group transfers should be kept out of the tax net," said Sudhir Kapadia, tax market leader, Ernst & Young. 
    Parts of the new tax provision came into effect from October 1, 2009; subsequently, the scope was extended in this year's Budget. But if the government does not spell out the details, it can lead to endless litigation. "For instance, 'fair value' has to be defined... Furthermore, rights issue is always at a discount to the market price, and in this case is the market price the fair value? In the absence of clarity, corporates should be careful while passing a rights issue, so that they don't come under the tax ambit," said senior chartered accountant Dilip V Lakhani of Lakhani & Co. 
    The pricing for a preferential offer is either two-week average or 26 weeks, whichever is higher. It's unclear whether this rule laid down by the capital market regulator will also be treated as 'fair value'. Cos wary of I-T impact on rejig 
SHEFALI Goradia, partner, BMR Associates, said: "Rights issue, bonus issue, preferential allotment will all be, strictly speaking, covered. However, this might be stretching the law to an illogical extension... And, while the receiver of shares will be taxed based on the current fair market value (FMV), he or she will not get any adjustment for any future drop in the FMV." 
    What's worrying many business groups is the difficulty they will face in corporate restructuring. Companies sell holdings or assets to group firms to attract private equity investors. From now on, corporates will have to watch out whether such transactions are happening at the fair value. Also, transfer of shares between an Indian company and its wholly-owned subsidiary at less than FMV may be taxed in the hands of the subsidiary. 
    "This is extending transfer pricing to domestic companies... All this will make corporate restructuring more difficult. In most countries, there is an exemption for transfer of shares within the group. This also goes against the basic tenet of taxation where only real income and not notional income should be taxed," said Ms Goradia. 
    While valuation norms are still to be announced, she feels that there will be a lot of hardships if the taxpayers have to justify that every transaction is at FMV. It's a provision where the tax net can be spread depending on how strictly one interprets it: 
    * The contribution of assets by partners to a firm will be hit, and the firm will have to offer deemed income to tax; 
    * Foreign venture capital investors with ratchet rights will also be impacted; while pricing guidelines don't apply to them, but they may have to pay tax on notional income, said a note by BMR. 
    * Buyback of shares may also be covered. 
    Under the provision, acquiring immovable assets (like land and properties) and specified movable assets without "consideration or inadequate consideration" would come under the tax net. The last Budget included bullion in the list of such assets. Since this will come into effect only from June 1, many individuals may take advantage of the situation. "If an assessee acquires bullion before June 1 and gives it to any other person who is not a relative, then it will not attract tax," said Mr Lakhani.