SEBI's Delisting Proposal: Tax Implications For Investment Holding Companies

In a bid to make the delisting process fair for investment holding companies, the Securities and Exchange Board of India—in its latest proposal—has come up with an alternate mechanism for them to delist.

The alternate framework, although welcome, has tax implications for the stakeholders involved, according to experts.

Investment holding companies' primary business is to hold investments in listed or unlisted companies. According to SEBI, these shares are often traded at a discount with respect to their underlying value, as the market considers their shares as long-term investments and doesn't expect them to be traded.

The present delisting regulations don't provide a different mechanism for delisting investment holding companies, forcing them to delist under the reverse book-building framework. As the market price and floor price are not reflective of the intrinsic value of the shares, the process often fails to provide a fair exit for public shareholders. In light of these concerns, SEBI has proposed an alternate framework for delisting such companies.

According to the proposed framework, an IHC may be delisted by swapping the public shareholders' shares in the company for the shares of the underlying listed companies. Subsequently, these shares are extinguished pursuant to a scheme approved by the National Company Law Tribunal.

This will mainly involve three steps, according to the regulator:

1. Share swap: The holding company, as the primary step, would transfer the shares held by it in other listed companies to their public shareholders. The shares transferred would be in proportion to the public holding in the IHC.

2. Payment against unlisted shares and other assets: As the next step, cash payments are made to the public shareholders against their stake in the unlisted investments and other such assets of the company.

3. Share extinguishment: As the final step, an NCLT-approved capital reduction scheme extinguishes the shares held by public shareholders.

The mechanism is, however, only available for a listed company that has at least 75% of its investments in listed companies. It would also require two votes in favour of the delisting from public shareholders for every unfavourable vote.

All these steps have simultaneous tax implications owing to the nature of the assets involved, said experts.

The present income tax laws consider shares as capital assets (unless they are held as stock in trade), and therefore, any gain accrued from the sale of such assets is considered a capital gain.

Since there are no particular provisions under the Income Tax Act that specifically deal with a share swap such as this, it would be considered a distribution of the assets of the company to its shareholders, said Amit Singhania, a partner at Shardul Amarchand Mangaldas and Co.

According to him, the tax implications at this stage are dual.

First, the holding company would have to pay a capital gain tax on the shares distributed to its shareholders. The rate of tax would depend on the kind of transaction, whether it was an on-market sale or an off-market transaction. It will also depend on the nature of the investment, whether it is a long-term or short-term one. Since the SEBI proposals signal an off-market transaction, the tax rate would be either 10% or 25%, depending on the nature of the investment.

Second, a simultaneous tax liability also arises for the public shareholder, he said. As the shares in the underlying listed companies are considered assets of the company, their distribution to its public shareholders would be considered a distribution of dividends to the extent of the accumulated profit held by the company. Since dividends, according to the IT law, are taxable at the hands of shareholders, they will be taxed as per the slab applicable (in the case of individuals) to them.

Experts said that a treatment similar to that of shares would be taken in the case of cash payments against unlisted shares and other assets.

They would be taxed as deemed dividends to the extent of the accumulated profit of the holding company at the hands of shareholders, said Vaibhav Gupta, a partner at Dhruva Advisors. The public shareholders would be subject to capital gains tax on any excess they received, he said.

At this stage, shares of the company are extinguished according to a scheme approved by the court. Under these circumstances, shareholders are usually taxed for the cancelled shares initially on the amount paid out by way of capital reduction as a dividend, to the extent that the company possesses accumulated profit. Anything beyond that is taxed as capital gains.

However, the scheme through which the shares are distributed and payments are made will be subject to the approval of the company law court, said Singhania.