Regulations pertaining to unlisted shares in India
It is important to know the regulations surrounding unlisted securities as an investor. Key aspects that an investor should know about relate to taxation and valuation. Given below are some important pointers that will be helpful.
- Taxation rules on profits: Profit generated on sale of unlisted shares is accounted as capital gains. Short term capital gain on sale of unlisted securities is currently taxable at 15%. Unlisted shares held for less than 24 months qualify under short-term capital gains tax. If the shares are held over 24 months, then they are accounted under long term capital gains (LTCG) tax and are taxable at 20% per annum. However, if the stocks have been held for long-term, then investors can benefit from indexation benefits.
- Taxation on unlisted stocks that are traded below fair value: When an investor of an unlisted share transfers the shares to any other person, he is required to pay Capital Gain tax on the difference between the sale consideration received by him and the cost of acquisition of such shares (or the inflation indexed cost, as applicable), as per Section 50CA. It is critical to check if the consideration amount that the investor received from the buyer is at least equal to or more than the “Fair Market Value” (“FMV”) as defined under Rule 11UA of The Income Tax Rules, of the unlisted shares sought to be transferred. If the investor receives sale consideration on sale/transfer of unquoted equity shares which is less than the FMV of such shares, the FMV of such shares shall be deemed to be the consideration received on such transfer of shares. Therefore, while computing the Capital Gains on transfer of unlisted shares, FMV of share will replace the actual sale consideration on transfer of such unquoted shares. The investor selling the shares, in such case, will have to pay Capital Gain tax on difference between FMV of the shares and cost price (or the inflation indexed cost price, as per the case) of such shares. As per Section 56(2), if the buyer investor acquires unlisted equity shares from a seller which is less than the FMV of such shares, the difference between the FMV of the shares and actual price paid by the buyer (if it exceeds Rs. 50,000/-) will be taxable in the hands of the buyer of unquoted shares under the head of “Income from Other Sources”. Please note here that both these rules are applicable only when the seller or the buyer, in respective cases, holds the shares as Capital Assets (Investment). This is not applicable when the shares are held as Stock in Trade.
- Adjustment of gains against basic exemption limits: An investor can gain tax exemption against basic exemption limits only if the investor is a resident individual/HUF. Additionally, investor has to first adjust income from all other sources other than LTCG against the exemption limit and then the remaining limit (if any) can be adjusted against LTCG.
- Valuation guidelines of SEBI for unlisted shares: Unlisted shares of a company will be valued based on the following approach mentioned below.
- Step 1: Arriving at Net worth per share. Diluted net worth per share needs to be computed after accounting for outstanding warrants and options and taking into account convertible shares.
- Step 2: 25% of the industry P/E ratio to be taken from comparable industry from BSE/NSE data.
- Step 3: The value of the net worth per share multiplied by the industry capitalization rate to be further discounted by 15% for illiquidity.
- Lock-in period: Investors who have purchased unlisted shares usually have a lock-in period of 1 year after the shares are listed in Initial Public Offering (IPO) on a stock exchange. However, before listing there is usually no lock-in period.
For more details or queries, please get in touch with us by writing back to us on unlistedinvestments@gmail.com. We will be happy to assist you with your doubts and even your trades.
Sources: www.sebi.gov.in, www.incometaxindia.gov.in/, www.business-standard.com, www.hindubusinessline.com