Conversion of preference shares into equity exempted from tax

NEW DELHI: In a big relief to private equity and venture capital firms who prefer buying convertible preference share, the government has exempted conversion of preference shares into equity from capital gain tax.

Earlier, the conversion of preference shares into equity was considered a transfer and thus attracted capital gains tax.

Most of the private equity firms prefer to make investments in the form of convertible preference shares.

Earlier, there was a doubt if conversion of preference shares into equity was going to be taxed or not.

IVCA President Rajat Tandon said that VC/PES often invest through cumulative convertible preference shares (CCPS). Now, CCPS, when converted, will be completely tax efficient and indexed from the date of issue and not from the date of conversion for longterm capital gain purposes.

“In order to provide tax neutrality to the conversion of preference share of a company into equity share of that company, it is proposed to amend section 47 to provide that the conversion of preference share of a company into its equity share shall not be regarded as transfer,” said the memorandum to the Finance Bill 2017.

The move is aimed at boosting investments in startups.

Under the existing provisions of the Act, conversion of security from one form to another is regarded as transfer for the purpose of levy of capital gains tax. However, tax neutrality to the conversion of bond or debenture of a company to share or debenture of that company is provided under the section 47.

Meanwhile, with the Budget proposing to withdraw long-term capital gains tax exemption if shares were purchased without paying STT, venture capital and private equity investors want clarity from the government to keep their investment in unlisted firms and the ESOPS exempted.

While the new provision is mainly aimed at checking misuse of this exemption for tax evasion through ‘sham transactions’ in stock market, it also provides for continued exemption for “genuine cases” where STT could not have been paid like in acquisition of shares in IPOS, FPOS, bonus or rights issue of shares by listed firms by non residents.