Tax guidelines on desire shares, CCDs

The funding situation over the previous few years has given start to a number of sorts of hybrid devices, every riddled with its personal set of complexities. Often, firms (usually startups) are issuing convertible devices (additionally known as quasi-equity devices) like Compulsorily Convertible Preference Shares (CCPS) or Compulsorily Convertible Debentures (CCDs) to shareholders/buyers. Ordinarily, these carry a nominal curiosity or dividend, which ought to be taxed as ‘any other income’ for an investor at relevant slab charges.

The phrases of those devices are usually ruled by the related shareholder’s settlement and until the time these will not be transformed, they might ordinarily acquire precedence over fairness shareholders underneath the liquidation hierarchy. The interval of holding of two years will apply for CCPS to be thought-about as long-term capital property however this era can be three years within the case of a CCD. The conversion of those CCPS or CCDs into fairness shares will not be handled as a switch underneath part 47 of the Income-tax Act, 1961, and therefore is not going to be topic to any capital good points tax, which shall be payable solely on the time of precise sale.

These devices pose another tax challenges as properly, significantly, when they’re unlisted, that the buyers or the businesses issuing these devices want to contemplate. The valuation of the devices is prescribed underneath Rule 11UA of the Income Tax Rules. For the difficulty of fairness shares, the principles are very clear as to the selection of strategies. At the time of difficulty, so as to set a cap on the valuation, both the Net Asset Value (NAV) technique or the Discounted Cash Flow (DCF) technique is prescribed. An instance is new-age firms, that are normally asset-light, ordinarily utilizing the DCF technique. At the time of switch by an investor, NAV technique of valuation with sure changes is required to be adopted. The intention of this provision is to set a flooring for the transaction for the aim of taxation.

However, in the case of devices apart from fairness (together with quasi-equity), the stated rule suggests using open market worth (OMV). This is at greatest a hazy time period as a result of for unquoted securities, it will be very tough to find out the OMV in lots of circumstances. The jurisprudence and literature accessible on the topic put it akin to FMV and therefore the valuers would usually use the normally accessible strategies of valuations. However, that leaves room for ambiguity because the tax division could problem the strategy of the corporate which can finally result in litigation. For instance, a valuer could use DCF technique to worth a CCPS having a face worth of ₹100 for a specific spherical and arrive at a valuation of ₹1,000 per share however the tax division could problem this, stating that DCF might not be acceptable as it isn’t fairness per se and ought to be considered a desire share solely and ought to be valued at its redemption worth (together with any dividends paid/payable within the interim) and therefore the distinction of ₹900 may very well be thought-about as an earnings within the fingers of the corporate.

Another difficulty is the disclosure of such shares within the tax returns of buyers. One of the tables within the normal schedule of the Income tax return type particularly requires disclosure of ‘unlisted equity shares’ held by the taxpayer at any time throughout the monetary yr. As talked about earlier, startups would normally be issuing CCPS/CCDs however using the phrase ‘unlisted equity shares’ makes it considerably ambiguous and if these are required to be disclosed on this desk or not. An interpretation might be taken that CCPS/CCDs will not be required to be reported on this desk however that would defeat the intent behind its introduction.

It is necessary to notice that taxpayers having earnings higher than ₹50 lakh are required to report all property in Schedule AL however solely the sum figures of investments and never the person funding is required to be reported. However, no disclosure for taxpayers beneath this stage of earnings is required however reporting of unlisted fairness shares is necessary for every particular person taxpayer within the tax returns. It is healthier to be on the conservative facet and it’s usually advisable to report CCPS/CCDs as properly on this desk. Hence, contemplating the intensive use of those devices, there may be an pressing have to suitably amend and to deal with the anomalies within the tax provisions to convey these devices at par with fairness shares, which is their important nature.

Sandeep Sehgal is a partner-tax at AKM Global, a tax and consulting agency.

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