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2017-03-28
As per the present tax laws, conversion of debentures into equity shares are specifically exempt under the Income Tax Act, 1961 (‘the Act’). However, there is no specific exemption given to conversion of compulsorily convertible preference shares (‘CCPS’) to equity shares. In the past differing views existed on taxability of conversion of CCPS into equity.
The Union Budget for the financial year 2017-18 (‘Budget 2017’) announced on 1st February has addressed the above concern regarding taxability of conversion of CCPS into equity.
Budget 2017 has proposed that conversion of CCPS to equity will not be regarded as taxable transfer. Corresponding amendments are also proposed in respect of cost of acquisition and period of holding of the equity shares received on conversion of the preference shares.
The holding period for resulting equity shares will now include the holding period of the preference shares and cost of acquisition of resulting equity shares will be cost of acquisition of preference shares in relation to which the equity shares was acquired by the investor.
As per present tax laws and prior to amendment to India-Mauritius and India-Singapore tax treaties, private equity firms investing in India through Mauritius or Singapore by subscription of CCPS of Indian entities were protected under the treaties on conversion of CCPS into equity and also on subsequent sale of the same.
Further, as per the amended treaties with Mauritius and Singapore, investment made in India prior to 31st March 2017 from Mauritius and Singapore is grandfathered i.e. the same would not be taxable in India. However, whether such grandfathering provisions are applicable for resultant equity shares on conversion post 31st March 2017 is not very clear.
In light of the above mentioned amendments, a private equity firm investing from a favourable jurisdiction (say Mauritius or Singapore) may have the following implications on conversion of CCPS and sale of such converted equity shares:
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Scenarios |
Implications |
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1. Conversion of CCPS – Pre 31stMarch 2017 2. Sale of equity – Pre 31stMarch 2017 |
1. Conversion of CCPS is exempt under the treaty. 2. Sale of equity shares is exempt under the treaty. |
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1. Conversion of CCPS – Pre 31stMarch 2017 2. Sale of equity – Post 31st March 2017 |
1. Conversion of CCPS is exempt under the treaty. 2. Sale of equity shares is exempt as it is grandfathered under the treaty (acquired prior to 31st March 2017). |
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1. Conversion of CCPS – Post 31stMarch 2017 2. Sale of equity – Post 31stMarch 2017 |
1. Conversion of CCPS is exempt under the Act as well as the Treaty. 2. However, there is lack of clarity under the treaty on taxability of sale of such equity shares as the treaty refers to the words -”shares acquired” - Does this mean the original investment or shares received on conversion? |
The governments of both the countries may consider clarifying whether the sale of converted equity shares would also enjoy the grandfathering benefit under the respective treaties considering the fact that the original CCPS were acquired prior to 31st March 2017 or alternatively the Indian government may consider clarifying or granting an exemption for such conversions under the tax laws.
In case the government clarification is not issued there may be future litigation on claim of treaty benefits on sale of such converted equity shares.
