Budget 2018 – Impact on M&A transactions

Nilesh Mody, Partner, M&A Tax, PwC India

With India inching towards election in 2019, a lot was expected from the Finance Minister in the 2018 budget. Many policy announcements focusing on development of agriculture, rural economy, healthcare etc. have been made in the Finance Bill, 2018 (‘Budget 2018’). At the same time, several amendments have been proposed in the Budget 2018, as far as direct tax is concerned. While some of the amendments (such as the amendments to section 79 and section 115JB) were much needed and welcomed by the industry, the reintroduction of long term capital gains on transfer of listed equity shares has been a dampener for the investor community, corporate world and promoters.

Long term capital gains tax on sale of equity shares, etc.

Long term capital gains tax on transfer of listed equity shares is one of the key amendments proposed in Budget 2018 that shall not only increase the transaction costs but may also require reevaluation of transaction structures (historical, as well as future ones).

Hitherto, long term capital gains tax arising on the transfer of listed equity shares was exempt under section 10(38) of the Income Tax Act, 1961 (‘the Act’). A new regime for taxation of long term capital gains exceeding INR 1 lakh, arising on the transfer of capital assets (being listed equity shares or a unit of an equity-oriented fund or a unit of a business trust) has been proposed for transfers effected on or after 1 April, 2018. This regime is applicable provided securities transaction tax (‘STT’) has been paid at the time of transfer of such capital assets and in the case of equity shares acquired after 1 October, 2004, STT has been paid at the time of acquisition as well.

Certain amendments were made to section 10(38) vide Finance Act, 2017, whereby the availability of the exemption was restricted in relation to transactions wherein STT had been paid at the time of acquisition of the equity shares. In order to clarify the doubts and allay the fears of the investor community concerning bona fide transactions which could also be denied exemption under section 10(38) due to the non-applicability of STT at the time of purchase, Notification No. 43/2017 dated 5 June, 2017 was issued by the Central Board of Direct Taxes (‘CBDT’) laying down the modes of acquisition to which the condition of payment of STT would not apply.

In Budget 2018, it was provided that the Central Government may notify acquisitions in respect of which payment of STT shall not apply. Vide FAQs issued by the CBDT on 4 February, 2018, it has been clarified that acquisitions excluded vide Notification No. 43/2017 dated 5 June, 2017 would be exempted from the condition of payment of STT. This provides a lot of clarity and would go a long way in reducing the uncertainty surrounding modes of acquisitions in the nature of gift/ succession/ bonus issue /rights issue /preferential allotment, etc.

The new regime, proposed to be covered under section 112A of the Act, provides for taxation of long term capital gains at the rate of 10% without allowing the benefit of indexation. It also provides for grandfathering of gains accrued up to 31 January, 2018. The grandfathering mechanism is included in the way the cost of acquisition of the long term capital assets acquired before 1 February, 2018 is computed. The cost shall be computed as per the mechanism tabulated below:


Scenario 1

Scenario 2

Scenario 3

Cost of Acquisition (purchased prior to January 31, 2018) – [A]




Fair Market value as on January 31, 2018 – [B]




Full value of consideration on ultimate sale post April 1, 2018 – [C]




Cost of acquisition for tax calculation [Higher of A and (lower of B and C)] –[D]




Capital gains [C-D] for 10% tax






The intent is to provide grandfathering and hence make this a prospective amendment, further it would avoid any panic sale by the investors before March 2018. However, the amendment would also increase the transaction costs, thereby reducing the rate of return for the investors, and would also amount to double taxation to the extent of STT payment. However, bonus shares acquired before 31 January 2018 would get cost which hitherto was nil.

Scope of ‘accumulated profits’ widened for the purposes of section 2(22)

An explanation has been added to section 2(22) dealing with deemed dividend under specified scenarios, providing that the accumulated profits of the amalgamating company shall also be considered in the hands of amalgamated company. This is an anti-abusive provision aimed at schemes resorting to wiping of accumulated profits of the transferor company resulting in subsequent reduction in taxability of deemed dividend transactions.

The amendment may pose practical challenges as position of reserves in books would be different as compared the position for tax and thus issues may arise in identification of accumulated profits where amalgamations have been effected several years back.

One pertinent point to note is that the amendment is proposed to apply to transactions effected on or 1 April, 2017. The amendment may cause hardship in cases where the transactions have been effected between 1 April, 2017 and 31 January, 2018.

Rationalisation of section 56 to include tax neutral transfers

Section 56 is a deeming fiction on transactions which are not for adequate consideration and are to be taxed in the hands of the recipient. Certain transactions covered under section 47 like merger, demerger etc are exempt. However, transactions between holding company and its 100% subsidiary company not exempted in section 56 may result in undue tax even though exempt under section 47. The Budget proposes to exempt the same from section 56 thereby removing the disparity.

Rationalisation of provision relating to conversion of stock-in-trade into capital asset

Section 28 dealing with profits and gains from business and profession is proposed to be amended to tax conversion of stock-in-trade into capital asset as business income by considering the fair market value of the stock as consideration. Consequently, section 49 dealing with cost of capital asset and section 2(42A) dealing with period of holding of capital asset are proposed to be amended to provide for fair market value as cost and commencement of holding period from date of conversion. This amendment shall have implications for sectors like real estate.

Rationalisation of section 43CA, 50C and 56 to provide for genuine cases

Section 43CA, section 50C and section 56 are deeming fiction taxing transactions in immovable properties where the sale consideration is lower than the stamp duty value of the property. The Budget proposes that the difference between stamp duty value and the consideration shall not be liable to tax where the variation between stamp duty value and sale consideration is not more than 5% of the sale consideration.

The proposed amendment would help in reducing hardship to taxpayers in genuine cases wherein the increase in the fair market value of the immovable properties has not been commensurate with the increase in stamp duty values of the said properties to some extent and also help in reducing litigation.

Amendments to solve the Insolvency conundrum

With the Insolvency and Bankruptcy Code, 2016 (‘IBC’) being implemented, a lot of traction has been witnessed in the restructuring of the companies holding stressed assets. However, potentially adverse tax implications many a time render the proposition commercially unviable and act as a deal breaker. Given this background, Budget 2018 has sought to bring in the following amendments for facilitating deals in the IBC space.

Relaxation of Section 79

It is proposed to relax the applicability of section 79, dealing with non-availability of losses in case of change in shareholding, to companies where a change in shareholding has taken place pursuant to a resolution plan approved under the IBC.

Deduction of loss and unabsorbed depreciation for book profit computation

It is proposed to amend section 115JB to provide that the aggregate amount of unabsorbed depreciation and brought forward loss (excluding unabsorbed depreciation) shall be allowed to be reduced from the book profit computation of a company whose application for corporate insolvency process under the IBC has been admitted by the Adjudicating Authority.

Prior to these amendments, the companies were dependent on NCLT for allowing these deductions. Pursuant to the proposed amendments, the relief shall be available to the companies under the provisions of the Act itself and obtaining specific relief from the NCLT would no longer be required. However, there are still a couple of other areas, wherein amendments are required for resolving typical issues faced in IBC transactions, and one hopes that the same would be incorporated in the final bill to be tabled in the Parliament.



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