Author Archives: novojuris

SEBI: Clarification on Clubbing of Investment limits for FPIs

The Securities Exchange Board of India (SEBI) in its meeting dated December 12, 2018, had decided that Beneficial Ownership (BO) criteria in Prevention of Money laundering (Maintenance of Records) Rules, 2005 should be made applicable for the purpose of KYC only and not for clubbing of investment of Foreign Portfolio Investors (FPIs).

Pursuant to that, SEBI has issued a clarificatory note (the “Clarification”) on December 13, 2018 which deals with this aspect.

Earlier, vide Circular No. CIR/IMD/FPIC/CIR/P/2018/132 dated September 21, 2018, it was laid down that Non Resident Indians (NRIs)/Overseas Citizens of India(OCIs)/Resident Indians(RIs) are allowed to be constituents of FPI subject to the maximum contribution to the corpus of FPI by NRI/OCI/RI including those of NRI/OCI/RI controlled investment manager should be below a 25% threshold from a single NRI/OCI/RI and below 50% in aggregate to the corpus of FPI.

Key Highlights of the Clarification:

  • The Clarification supersedes SEBI Circular No. CIR/IMD/FPIC/CIR/P/2018/64 (‘KYC Requirements for FPI’) and partially modifies SEBI Circular No. SEBI/HO/IMD/FPIC/CIR/P/2018/66 (‘Clarification on clubbing of Investment limits of FPI’) both dated April 10, 2018.
  • Clubbing of investment limits for FPI will be on the basis of common ownership of more than 50% or based on common control, and not Beneficial Ownership.

Control includes the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

  • Exemption from clubbing of Investment limits is provided for the FPIs which are:
    1. appropriately regulated by public retail funds; or
    2. public retail funds majority owned by appropriately regulated public retail funds majority owned by appropriately regulated public retail funds on look through basis; or
  • public retail funds and investment managers of such FPI are appropriately regulated.

Public retail funds mean (i) mutual funds or unit trusts which are open for subscription to retail investors and do not have specific investor type requirements e.g.  accredited investors etc, (ii) insurance companies where segregated portfolio with one to one correlation with a single investor is not maintained and (iii) pension funds.

  • It clarifies that, if two or more FPIs including foreign governments/ related entities are having direct or indirect common ownership of more than 50% or control all such FPIs will be treated as forming part of an investor group and the clubbing would apply.
  • Investment of foreign government agencies shall be clubbed with the investment by foreign govt./ its related entities for the purpose of calculation of 10% limit of FPI investments in a single company, if they form part of an investor group.
  • Investments from foreign government or its related entities from provinces/ states of countries following a federal structure shall not be clubbed if the foreign entities have different ownership and control.
  • In cases of breach of clubbing limits an FPI will either:
    1. Divest its holding within five trading days from the date of settlement of trades to bring its shareholding below 10% of the paid-up capital of the company; or
    2. treat the said investment shall be treated as FDI from the date of breach and comply accordingly.

Source: https://www.sebi.gov.in/legal/circulars/dec-2018/clarification-on-clubbing-of-investment-limits-of-foreign-portfolio-investors-fpis-_41281.html

https://www.sebi.gov.in/legal/circulars/sep-2018/eligibility-conditions-for-foreign-portfolio-investors-fpis-_40409.html

https://www.sebi.gov.in/legal/circulars/apr-2018/know-your-client-requirements-for-foreign-portfolio-investors-fpis-_38618.html

https://www.sebi.gov.in/legal/circulars/apr-2018/clarification-on-clubbing-of-investment-limits-of-foreign-government-foreign-government-related-entities_38616.html

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Significant Beneficial Owners Rules – Disclosures

SEBI vide its circular number SEBI/HO/CFD/CMD1/CIR/P/2018/0000000149 dated December 7, 2018 issued this circular in  exercise  of  the  powers  conferred  under  Section  11  and Section  11A  of  the  Securities  and  Exchange  Board  of  India  Act,  1992  read  with Regulation 31 and Regulation 101(2) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, in the in the interest of transparency.

This circular is in furtherance to the previous circulars and notifications (SEBI Circular No.  CIR/CFD/CMD/13/2015 and Companies (Significant Beneficial Owners) Rules, 2018 notified June 2018 by the Ministry of Corporate Affairs). SEBI clarified and laid down specific disclosures with respect to the shareholding pattern to determine the significant beneficial ownership.

Highlights:

  • Modification: The format specified in the Annexure to the circular shall be Table V  under clause  5 of  the format of  holding  of  specified  securities specified  in  the circular No. CIR/CFD/CMD/13/2015 dated November 30, 2015.
  • Disclosure: contents of the circular to be brought to notice of all listed entities and onus on stock exchange to disseminate this information though notice and publication in website
  • Annexure contains details of-
  • (i) Significant Beneficial Owner (Name, PAN, Nationality)
  • (ii) Registered Owner (Name, PAN, Nationality)
  • (iii) Particulars of shares held by significant beneficial owner which amount to significant beneficial ownership (the quantum of shares in the form of – exact number, percentage of the total number of shares)
  • (iv) Date of creation of Significant beneficial interest (/acquisition of the shares)

The manner of disclosure, as specified in the Annexure (tabular form) to the circular, will come to force from the quarter ending 31 March 2019.

LINK: https://www.sebi.gov.in/legal/circulars/dec-2018/disclosure-of-significant-beneficial-ownership-in-the-shareholding-pattern_41245.html

SEBI: Early warning mechanism to prevent diversion of client securities

Considering the instances where the Stockbrokers have diverted client securities, observed that these diversions were coming to light on failure of these stockbrokers to meet margin and/ or settlement obligations to Stock Exchange/ Clearing Corporation. In this regard, the Securities Exchange Board of India (SEBI), noted the thrust of these diversions towards raising loan against shares on their own account and/ or for meeting securities shortages in settlement obligations and decided on establishing an Early Warning Mechanism as well as facilitating the sharing of information between Stock Exchanges, Depositories and Clearing Corporations.

Aiming at ensuring the effective detection through the insertion of these systems which connect different platforms, SEBI left the threshold for the early warning signals to the discretion of the Stock Exchanges, Depositories and Clearing Corporations, who had to decide this threhold with mutual consultation.

Highlights:

SEBI suggested an indicative criteria of what these early warning signals for the prevention of such diversions could include. The early warning signals were divided into 5 categories:

1.Deterioration in financial health of the stock broker/ depository participant

The parameters for the deterioration were laid out from 3.1 a) to j) and included aspects such as a significant reduction in the net worth, losses including significant mark-to-market loss, delays in reporting requirements, both regarding its financial health and regarding related party dealings, significant activity in dormant accounts, resignation of key personnel (statutory auditors or directors).

2. Securities pledge transactions by the stock broker that are to be identified by the Depositories and shared with Stock Exchanges

Such early warning signals may include alerts for stockbrokers maintaining multiple proprietary accounts, transfer/movement/depletion of large magnitude of shares as well as invocation of pledges of securities.

3. Increase in the number of complaints on grounds of unauthorized trading/ unauthorized delivery instructions being processed and non-receipt of funds and securities.

4.Alerts through the Risk Based Supervision (RBS) or Enhanced Supervision to the Stock Exchanges

Failure to upload required weekly data or misreporting/wrong reporting on such uploads, significant increase in RBS score, recovery and non-recovery of the significant dues to the credit and debit balance respectively.

5.The disabling of stock broker’s terminal for certain number of days in any segment / Stock Exchange in previous quarter

Framing an internal policy: SEBI requires the Stock Exchanges and Depositories to frame internal policies/ guidelines regarding non- cooperation by stock brokers and depository participants during inspections. These policies must lay down the time period, the type of documents critical for closing the inspections. Non-submission of these can be treated as non-cooperation.

  • Mechanism to detect diversion of clients’ securities and effective sharing of information: The information shared amongst stock exchanges includes information regarding- unauthorised/fraudulent transfers, information and clarifications regarding mis-matches, diversion of pay-out securities to non-client account.
  • Alerts triggered at place shared to all other participants.
  • A non-exhaustive list of actions that can be initiated by stock exchanges includes: imposition of limits, cross-checking of details, conducting meetings, undertaking uniform action of deactivation of trading terminals, blocking certain percentage of available collateral.
  • Actions that can be taken by depositories include and are not limited to, restriction of further pledges, impositions of concurrent audits and restrictions (to the point of cessation) on uses of Power of Attorney.

The mechanism suggested in this circular is to be implemented with effect from 1 February 2019 and all Stock Exchanges, Clearing Corporations and Depositories must adopt the suggested mechanism along with preventive actions.

Sources: https://www.sebi.gov.in/legal/circulars/dec-2018/early-warning-mechanism-to-prevent-diversion-of-client-securities_41315.html

Proposed amendments to Cinematograph Act – Stringent penalties for copying a film

The Ministry of Information and Broadcasting (“Ministry”) vide a public notice has invited comments from the public regarding the proposed Cinematograph Act (Amendment) Bill.

The Ministry proposes stringent penalties for recording, attempting to record or abetting the recording or transmission of a film or part thereof by introducing a new sub-section, that is, sub-section (4) of section 7 in the Act which currently reads as follows:

“Notwithstanding any law for the time being in force including any provision of the Copyright Act, 1957, any person who, during the exhibition of an audiovisual work, cinematographic in an exhibition facility used to exhibit cinematograph films or audiovisual recordings and without the written authorization of the copyright owner, uses any audiovisual recording device to knowingly make or transmit or attempt to make or transmit or abet the making or transmission of a copy or visual recording or sound recording embodying a cinematograph film or audiovisual recording or any part thereof or a copy of sound recording accompanying such cinematograph film or audiovisual recording or any part thereof during subsistence of copyright in such cinematograph film or sound recording, shall be punishable with imprisonment not exceeding three years and shall also be liable to fine not exceeding Rs.10 Lakhs, or to a term of imprisonment for a term not exceeding three years or both.”

The proposed provision uses non-obstante language to over-ride any existing law including the Copyright Act, 1957. This seems unjustified as the objective of the Cinematograph Act is to regulate the certification of cinematograph films for exhibition and that of the Copyright Act is to protect copyright. Hence the piracy issue should have been dealt with by amending the Copyright Act instead of the Cinematograph Act.

Further the proposed provision prescribes a stringent penalty of imprisonment for up to three years with the possibility of an additional fine.

References:

  1. Public notice seeking comments on the draft amendment to the Cinematograph Act-

https://mib.gov.in/sites/default/files/Public%20Notice%20-%20Amendment%20of%20Cinematograph%20Act%20Bill.pdf

  1. Cinematograph Act, 1952.

Tokenisation of card transactions – RBI notifies

RBI vide its notification no. RBI/2018-19/103 dated 8 January 2019 has permitted authorised card payment networks to offer card tokenisation services to any token requestor i.e. a third party application subject to certain conditions.

Conditions to be fulfilled

  • Tokenisation and de-tokenisation services shall only be performed by authorised card networks and the recovery of Primary Account Number (PAN) should be feasible for the authorised card networks only. Safeguards should be put in place to ensure that PAN details cannot be found from the token and vice versa.
  • The requests for tokenisation and de-tokenisation shall be logged by the card network and available for retrieval.
  • The actual card data, token, and other relevant details shall be stored in a secure mode. Token requestors shall not store PAN or any other card details.
  • Card networks shall get the token requestor certified for (a) token requestor’s systems, including hardware deployed for this purpose, (b) security of token requestor’s application, (c) features for ensuring authorised access to token requestor’s app on the identified device, and, (d) other functions performed by the token requestor, including customer on-boarding, token provisioning and storage, data storage, transaction processing, etc.
  • The card networks shall get the different entities involved in the payment transaction chain certified with respect to the changes done for processing the tokenised card transaction.
  • All the certification and the security testing by the card networks shall conform to the international best practices or globally accepted standards.
  • Additional conditions have been prescribed for the registration of card details by a customer such as: (a) the registration of card on the token requestor’s app shall only be done via taking the explicit customer consent though additional factor of authentication (“AFA”) and not by way of a forced/default/automatic selection of check box, radio button etc. (b) The AFA validation during card registration as well for authenticating any transactions shall be as per the RBI’s instructions, (c) Customers will have the option to register or deregister their card for a particular purpose i.e. contactless, QR code based, in-app payments, etc. (d) Customers will have the option to set and modify per transaction and daily transaction limit for such transactions. (e) Velocity checks may be put in place by card issuers/card networks (f) The customer shall be free to use any card registered with the token requestor app for performing a transaction.
  • Secure storage of token and associated keys should be ensured by the token requestor on successful registration of card.
  • Customer support services such as reporting the loss of an identified device or any other event which may expose the token to unauthorised usage shall be put in place by the card network along with providing for a dispute resolution process.

The permission has been granted for all channels such as near field communication (NFC), in-app payments, QR code based payments etc. or token storage mechanisms such as cloud, secure element, etc. At present the facility shall be offered through mobile phones or tablets only.

Safety mechanism

RBI issued instructions on safety and security of card transactions including the mandate for an AFA/ PIN which shall be applicable for tokenised transactions along with other instructions issued by RBI from time to time.

Service fee

RBI dictates that no charges should be recovered from the customers for availing tokenisation services.

Monitoring mechanism

Periodic system audits shall be conducted at least once a year by the authorised card payment networks. This system audit shall be undertaken by the auditors of India Computer Emergency Response Team (CERT-IN) and all the instructions with regard to system audit shall also be complied with. A copy of the audit report shall be furnished to the RBI with comments of auditors with regard to any deviations. Further, a report with certain details needs to be submitted on a monthly basis to the Chief General Manager, Reserve Bank of India.

References

  1. Tokenisation refers to replacement of actual card details with an(sic) unique alternate code called the “token”, which shall be unique for a combination of card, token requestor and device (referred hereafter as “identified device”)
  2. https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11449&Mode=0

RBI directive to limit customer liabilities

RBI issues directive limiting the liability of customers in unauthorised electronic payment transactions in Prepaid Payment Instruments issued by authorised Non-Bank Issuers.

The Reserve Bank of India (RBI) vide its Notification No. DPSS.CO.PD.No.1417/02.14.006/2018-19 dated 4 January 2019 (“the Directive”) has taken steps to limit the liability of customers in respect of unauthorized electronic payment transactions through Prepaid Payment Instruments (PPIs) issued by Authorised Non-banks. The said Directive should be read alongside with the paragraphs 15 and 16 of RBI’s Master Direction on Issuance and Operation of Prepaid Payment Instruments (“the PPI Master Direction) which already provides a framework for ‘Risk Management’ and ‘Customer Protection’. Under the present Directive, the criteria for determining customers’ liability under the extant framework have been further reviewed.

The provisions of the Directive will be applicable to all authorised non-bank PPI issuers only. Bank PPI issuers will not have to follow the provisions of the Directive. Furthermore, PPI for Mass Transit Systems (PPI-MTS) will be outside the purview of the Directive, except for cases of contributory fraud/ negligence/ deficiency on the part of the PPI-MTS.

For the purpose of the Directive, electronic payment transactions have been divided into two categories for the purpose of the Directive:

  • Remote/Online payments transactions e.g. wallets, card not present (CNP) transactions.
  • Face-to-face/Proximity payment transactions e.g. transactions at point of sale.

The Directive brings forth the following two important changes:

Reporting of unauthorised payment transactions by customers to PPI issuers:

PPI issuers will have to comply with the following conditions:

  1. PPI issuers must ensure that their customers mandatorily register for SMS alert or e-mail alerts (wherever available), and that mandatory SMS or e-mail alert is sent to the customers, and the transaction alert has a contact number and / or e-mail id on which the customer can report unauthorised transactions or notify the objection. Customers must also have 24´7 access via website, SMS, e-mail, or a dedicated toll-free helpline number.
  2. Customers must be advised by the PPI issuers to notify the PPI issuer of any unauthorized electronic payment transaction at the earliest, and that the longer the customer takes to notify the PPI issuer, the higher will be liability of the customer.

A direct link for lodging complaints, with a specific option to report unauthorized transactions, must be provided by PPI issuers on their mobile app, home page of website, or any other evolving acceptance mode. PPI issuers must ensure to resolve the complaint within 90 days from the receipt of the complaint.

  1. PPI issuers should have in place a loss/ fraud reporting system to send immediate response (including auto-response) to customers acknowledging the complaint. All the relevant data pertaining to time and date of deliveries and receipt of customer response must also be recorded within the PPI issuers’ systems.
  1. Limited Liability of a customer:

The Directive limits the liability of customers in stipulated cases based on the number of days the customer takes to report the issue, the longer time the customer takes to report, the higher is his/her liability. The classification of liability is broken down as follows:

  • In case of contributory fraud/negligence/deficiency on part of the PPI issuer, there is no liability of customer.
  • In case of a third-party breach, i.e. neither the customer nor the PPI issuer being responsible for the deficiency, the customer liability will depend upon the number of days lapsed between receipt of transaction communication and the reporting of unauthorised transaction by the customer-
  • If within three days, then no customer liability.
  • If within four to seven days then customer will be liable for the transaction value or Rs. 10,000 per transaction, whichever is lower
  • Beyond seven days the customer liability will be as per the approved policy of the board of directors of the PPI issuer.
  • In case where the loss is due to the negligence of the customer, i.e. cases where customer shares the payment credentials themselves, the customer will bear the entire loss until the customer reports the unauthorised transaction to the PPI issuer. If any loss occurs after the reporting of the unauthorized transaction, it shall be borne by the PPI issuer.

PPI issuers may also decide to waive off any customer liability at their own discretion even if it involves customer’s negligence.

Even in cases where customers are sought to made liable, the burden of proof of negligence/deficiency/liability shall at all times lie with the PPI issuers. Further, the Directive requires the PPI issuer to credit the amount involved in unauthorized transaction within 10 days from the date when customer notifies the PPI issuer about unauthorised electronic payment. This should be done even if such reversal breaches the maximum permissible limit applicable to that type / category of PPI.

The Directive also imposes important compliances in the form of requirement for a board approved policy for customer protection, reporting and monitoring of compliances.

Source: https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT101746BAE75BB964EB1AD2E5BB6DC3FE5DC.PDF

Capital Gains Tax on Conversion of Compulsorily Convertible Preference Shares – The Current Scenario

The question of taxability on conversion of compulsorily convertible preference shares (CCPS) has come up for consideration quite a few times in the recent past. There seemed to be ambiguity regarding whether an event of conversion amounts to ‘transfer’ under Section 2(47) of the Income Tax Act, 1961 (the “Act”), thereby triggering capital gains tax under Section 45 of the Act.

As early as 12 May 1964, the Central Board of Direct Taxes (CBDT) in its Circular F. No. 12/1/64-IT(A) (the “Circular”) had stated that where one type of share is converted into another type of share, there is no ‘transfer’ of capital asset within the meaning of Section 2(47) of the Act. However, there have been many instances when assessments have still been framed adversely. The matter of Periar Trading Company Limited v Income Tax Officer[1] (the “Periar Case”) is one such instance where the conversion of preference shares was sought to be taxed and the above question again came up for consideration. The decision in this case pronounced by the Mumbai bench of the Income Tax Appellate Tribunal (ITAT) further consolidates the position that CCPS would not attract any capital gains tax upon conversion. In this post, we look into the facts of the Periar Case and the reasoning adopted by Hon’ble Justice Mahavir Singh for pronouncing the judgment.

Factual Matrix of the case:

  • Perirar Trading Company Pvt Ltd (the “Assessee”) was engaged in the business of investment activities.
  • During the financial year 2010-11 relevant to the assessment year 2011-12, the Assessee had made investment in 51,634 CCPS of Series A of Trent Ltd. on a rights issue basis. The entire issue price of the said CCPS was paid on application itself.
  • As per the terms of the scheme for issue of CCPS, one CCPS of Series A would compulsorily and automatically get converted into one fully paid up equity share. Accordingly, on 10 September 2011, the Assessee was allotted one equity share of Trent Ltd. for every preference share held in Trent Ltd., i.e. 51,634 CCPS. The conversion was compulsory and automatic.
  • The Assessing Officer (the “AO”) noted from the schedule of non-current investment forming part of the balance sheet of the Assessee for the previous year 2011-12 that the Assessee company had its 51,634 CCPS Series A of Trent Ltd into equity shares and thus, during the assessment year 2012-13, sought to tax the Assessee, treating the conversion of CCPS into equity shares as a ‘Transfer’ within the meaning of the definition provided in section 2(47)(i) of the Act.
  • The Assessee brought the matter before the Commissioner of Income Tax (Appeals) [the “CIT(A)”], which accepted the AO’s arguments and relied on rulings in Re: The Nizam’s Second Supplementary Family Trust[2] and CIT v Santosh L Chowgule[3] to reject the Assessee’s appeal holding that the conversion of the CCPS amounted to a ‘transfer’ by way of exchange.
  • Aggrieved by the same the Assesee preferred appeal to the Mumbai bench of the ITAT.

Main Issue before the ITAT:

The ITAT was primarily faced with the question of, “Whether the action of CIT in confirming the action of AO to treat the conversion of Cumulative Compulsory Convertible Preference Shares (CCPS) into equity shares as transfer within the meaning of section 2(47) of the Act on the said conversion, was proper in law?” In dealing with the issue the decision also touches upon the following points:

  • Modality of calculating period of holding in the case of conversion and subsequent sale/transfer of the converted CCPS? and
  • The distinction between exchange and conversion of shares.

Arguments of the Assessing Officer (AO):

It was contended by the AO that the difference of,

  • (i) the market value of converted number of equity shares of Trent Ltd. and
  • (ii) the cost of the acquisition of equal number of CCPS Series A of Trent Ltd

is taxable as capital gains on account of transfer of shares by way of exchange of ‘assets’. The AO also relied on the definition of ‘exchange’ as per the Black’s Law Dictionary in support of his reasoning.

Reasoning adopted by the CIT(A):

Before the CIT (A), the AO relied on the case of Re: The Nizam’s Second Supplementary Family Trust[4], in which Hon’ble Andhra Pradesh High Court categorically held that conversion of preference shares into equity shares is nothing but a barter, which constitute transfer by way of exchange within the meaning of Section 45 of the Act. The CIT-A therefore held that the ratio of the above case should be applicable to the case of the Assessee and that the Assessee must pay the amount as long term taxable capital gain.

Arguments of the Assessee before the ITAT:

The Assessee contended that the legislative scheme emanating from the provisions of the Act also did not require such transaction to be taxable. The Assessee relied on section 55(2)(b)(v)(e) of the Income Tax Act which states that where the newly converted share is transferred at a later date, then, the cost of acquisition of such share for the purpose of computing the capital gain tax shall be calculated with reference to the cost of acquisition of the original share from which it is derived. Thus, the legislative intent seems to be clear that conversion ought to be regarded as tax neutral.

Rulings of the ITAT:

The ITAT held that the CBDT vide the Circular has clarified the position that where one type of share is converted into another type of share, there is no transfer of capital asset within the meaning of Sec. 2(47) of the Act. It also noted that the provisions of the circular have also been adopted in the tribunal’s earlier judgment in ITO v Vijay M Merchant[5].

The ITAT further relied on the ruling in Gillanders Arbuthnot & Co[6] and Texspin Engineering and Manufacturing Works[7] to hold that the market value of the converted equity shares on the date of conversion shares resulting from the conversion cannot be treated as ‘full value of consideration’ of the CCPS, even if such conversion was treated as a transfer, for the purpose of determining capital gains under section 48 of the Income Tax Act, 1961. The Supreme Court in Gillanders[8] faced a similar case where the value of asset transferred in lieu of shares was sought to be the ‘full value of consideration’, the Apex Court had observed that ‘full value of consideration’ is inherently different from ‘fair market value of the capital asset transferred’. Further in Texspin[9], the Bombay High Court had held that one has to read the expression ‘full value of consideration’ under section 48 dehors section 45 and that the expression cannot be used to mean the market value of the capital asset on the date of the transfer.

The ITAT further observed that the present case was not a case where “one form of share has been exchanged, bartered, swapped for other form of share. In the present case, one type of share was converted into other type and the earlier type of share has ceased to exist. Thus, there is no exchange of any share as the pre-conversion security has ceased to exist. From the above, it is evident that mere conversion of one type of share to other type of share will not be a transfer of a capital asset within the meaning of Sec. 2(47) of the Act.” ITAT further pointed out that AO’s reliance on the ruling of the Hon’ble Supreme Court in the CIT v Motors & General Stores Pvt Ltd[10] was unfounded, as the Court therein had held the exchange of cinema house to preference shares is to be considered as a transfer for the purpose of taxability. The facts of the matters are, therefore, entirely different.

The ITAT accepted the interpretation of the Assessee, claiming this to be in furtherance to the legislative intention, that mere conversion of one type of share to other type of share will not be a transfer of a capital asset within the meaning of Sec. 2(47) of the Income Tax Act, 1961, which would also make the provision of capital gains work smoothly, in synchronization with other provisions, without any conflict with other provisions. If the view is adopted that capital gain tax liability arose upon conversion, then the same would be not only against the legislative intention but also would make the composition of capital gains unworkable and would bring conflict with other provisions of the Act. In fact, it would lead to instances of double taxation, as having taxed the capital gain upon such conversion, at the time of computing capital gain upon sale of such converted shares, the Assessee would be still taxed again, as the cost of acquisition would still be adopted as the issue price of the CCPS and not the consideration adopted while levying capital gain upon such conversion. The tribunal in this regard noted “by no stretch of imagination, such interpretation process is permissible”.

Key Takeaways:

Although now there is a specific provision in the form of Section 47(xb) (with effect from 1 April, 2018), the decision comes as a boon for matters where conversion took place even before the Finance Act, 2017 came into force. Further, to consolidate the mandate under Section 55(2)(b)(v)(e), the Finance Act, 2017 has also introduced new provisions in form of Sections 2(42A)(hf) and 49(2AE) that provide that holding period of equity shares resulting from conversion of preference shares start from the date of acquisition of original preference shares. The position of law with respect to taxability of conversion events now seems to be well settled therefore.

Authors: Mr. Avaneesh Satyang and Ms. Sohini Mandal

[1] ITA No. 1944/Mum/2018 decided on 09 November 2018

[2] (1976) 102 ITR 248 (Andhra Pradesh)

[3] (1998) 234 ITR 787 (Bombay), wherein the Bombay High Court held that preference shares and equity shares are different.

[4] Supra note 2

[5] (1986) 12 ITD 510 (Bombay)

[6] 66 ITR 622 (Supreme Court)

[7] 263 ITR 345 (Bombay)

[8] Supra note 6

[9] Supra note 7

[10] (1967) 66 ITR 692 (SC)