Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Loss on sale of shares within lock- in period to group company
disallowed and held as sham transaction
February 16, 2016
In brief
The Delhi Income-tax Appellant Tribunal (Tribunal), in a recent case, held that the taxpayer’s
transaction of purchase of shares from a group concern, and their later sale to the same concern, both during the lock-in period as per Securities and Exchange Board of India (SEBI) regulations2, was a sham transaction, and therefore disallowed short-term capital loss (STCL) arising on sale of these shares.
In detail
Facts
The taxpayer1 and
Company A were part of a group of companies with the same set of directors.
Company A held share warrants of Company B (a listed company) obtained under preferential allotment (issued in March 2006) with an option to convert each share warrant into one equity share at a price of INR 84 per share, 10% of which was payable upfront and the balance 90% at the time of conversion into equity shares.
One of the conditions of the preferential allotment was that failure to exercise conversion option before 29 September, 2007 would result in the forfeiture of the
1 TS-57-ITAT-2016 (Delhi-Tribunal)
initial 10% amount paid by the allottees.
At the time of conversion into equity shares, Company A did not have adequate funds for payment of conversion price, and therefore approached the taxpayer to finance the balance 90% of the
conversion price and in turn acquire the equity shares of Company B from Company A at a price of INR 84 per share. The market value of these shares at that time was between INR 106 and INR 133 per share.
The shares were not transferred to the taxpayer’s name due to imposition of lock-in period till March 2009 as prescribed under relevant SEBI Guidelines2.
2 Regulation 78 of Securities and Exchange Board of India (Issue of
In September 2008, the taxpayer sold shares of Company B in an off- market transaction back to Company A at a price of INR 54 per share. It accordingly claimed STCL on such sale transaction.
The market price of Company B’s shares on the Bombay Stock Exchange at the time of this sale was INR 59 per share.
Issue before the Tribunal Whether the transactions entered into by the taxpayer was a sham transaction, thereby meriting disallowance of the STCL claimed by the taxpayer.
Taxpayer’s contentions
Acquisition of Company B’s shares from Company A could not be recorded immediately in the taxpayer’s name as there
Capital and Disclosure Requirements) Regulations, 2009
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was a lock-in period, but the taxpayer had acquired full beneficial interest in the shares as an owner. Only transfer of shares was barred during the lock-in period, and there was no prohibition by SEBI on sale of shares by Company A.
The taxpayer faced huge tax demands, for which it had to liquidate the investments, but since the shares were neither tradeable on the stock exchange, nor transferable before the 3-year lock-in period, the taxpayer
negotiated with Company A to purchase these shares. The sale price was fair considering the illiquidity of the shares at the time of transfer.
The taxpayer contended that the transaction could not be termed as a sham merely because it was between two group companies. The
taxpayer produced a tripartite agreement and transfer of funds receipts to support its contention that the
transactions were genuine.
The taxpayer also supported the genuineness of
transactions by contending that the capital loss declared was not adjusted by the taxpayer till the date of hearing before the Tribunal, i.e., 27 November, 2015.
Revenue’s contention
An agreement entered by the taxpayer could not override the statutory conditions of the preferential allotment. The taxpayer was not legally entitled to purchase the shares, and there was no question of selling them back to Company A. As per the agreement, shares could be transferred only after the lock-in period, which in this case was 31 March, 2009.
3 ACIT v. Biraj Investment Private Limited [2012] 82 CCH 180 (Gujarat)
Theoretically, the taxpayer could not be allowed to sell the shares at less than the market price as on a given date, even in an off-market transaction.
The taxpayer had submitted tax payment challans
pertaining to assessment year 2006-07, which could not be held as relevant and good cause for selling the impugned shares in September 2008 during the lock-in period.
Both, the taxpayer and Company A, were under the same management, and the transaction of purchase and sale during the lock-in period was rightly held as a sham transaction by the lower authorities, as it was legally prohibited during the lock-in period.
As the taxpayer had no right to sell the shares during the lock-in period, any
transaction without transfer to the buyer’s name had to be held as being a speculative transaction; it could not be held as an acceptable STCL.
Tribunal ruling
Transaction of sale and
purchase was legally prohibited during lock-in period. Purchase and sale of shares without a legally permissible physical transfer of shares was a sham transaction, and the STCL generated on such a transaction could not be allowed.
The Tribunal agreed with the Gujarat High Court (HC) ruling in Biraj Investments3 and Madras HC ruling in M.
Ramaswamy4, about the transferee gaining rights of ownership even though his name was not entered in the register of members. However, it distinguished the taxpayer’s case on the ground that the current transaction was
4 CIT v. Ramaswamy [1985] 151 ITR 122 (Madras)
entered into during the lock-in period, and was effected between group companies.
The Tribunal took note of the fact that the taxpayer, Company A and Company B were all part of the same group, and thus agreed with the lower authorities’ findings that the sale of shares effected between two group companies having the same directors, during the lock-in period was without any good cause.
The Tribunal pointed out that no document was submitted by the taxpayer to show payment of tax demands out of the proceeds of sale of investments, and the urgency and necessity to pay tax demands shown by the taxpayer could not be held as tenable/ acceptable.
The Tribunal upheld the Tax Officer’s impugned order, and confirmed the disallowance and addition made by him.
The takeaways
The Tribunal, based on specific facts, held that purchase and sale of shares during the lock-in period was not permissible and legally prohibited, and thus was a sham transaction. The taxpayer’s explanation for such sale was factually incorrect, and accordingly not acceptable.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact:
Tax & Regulatory Services – Mergers and Acquisitions Gautam Mehra, Mumbai +91-22 6689 1154
[email protected] Hiten Kotak, Mumbai +91-22 6689 1288 [email protected]
Tax Insights
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