Are you eligible to invest in private equity shares in India?
Yes.
My unlisted portfolio has delivered higher returns than listed cos investments: Rakesh Jhunjhunwala.
Investment in the equity shares of privately held Indian companies has become a real -game-changer for investors’ portfolios. And if I were to list a few multi-baggers from this boom-bound market, I would principally list Mahendra Singh Dhoni-led Chennai Super Kings. Although, MSD had nothing much to do with it! Well, the point here is that the shares of 2021 IPL titleholders were worth 21.5 INR as of February 14, 2019, post which the price skyrocketed and has now reached astounding levels of 165 INR as of December 11, 2021. And it’s not just CSK who are achieving off the field. The private equity shares of Reliance Retail have also registered a spike of a whopping 300% along with the claims of NSE, which moved from 1,000 INR in March 2020 to 3,600 INR in December 2021.
Mr. Jhunjhunwala’s statement makes sense, right?
But as Uncle Ben said, With great power comes great responsibility.
Likewise, there is a saying in the financial universe: With the significant accumulation of wealth and registry of unbelievable returns comes the great responsibility of serving society by paying TAXES!
Although we all refrain from breaking our heads over comprehending regulations and taxation aspects, we usually reach out to our CA.
However, we here at Precize believe in empowering our users by providing them with carts to carry their private equity shares and aiding everyone in building more pronounced investing insight that helps you stand out! Therefore, we have got you the delicacy of regulation & taxation in today’s platter.
A brief explanation of the following terms
- FMV — Fair Market Value (FMV) is an estimated value of private equity shares at which they would have possibly traded if the same shares were listed on an exchange.
- Sale Consideration is the money transferred from the buyer of private equity shares to the seller.
- The exercise price is the price of private equity shares mentioned under the Employee Stock Option Plan (ESOP) document.
- Cost of acquisition is the amount paid by the buyer of private equity shares to the seller of the same.
- Indexation benefit is an adjustment made to the purchase price of any investment due to the prolonging effect of inflation throughout the holding period.
- LTCG — Long Term Capital Gain (LTCG) is the profit/gain from an investment held for more than a specified period.
(About investments in private equity shares, LTCG is taxed at 20% with indexation benefit if unlisted shares are held for more than 24 months )
7. STCG — Short Term Capital Gain (STCG) is the amount of profit/gain made from an investment held for less than or equal to a specified period.
(About investments in private equity shares, STCG is taxed if unlisted shares have been held for less than or equal to 24 months. The tax rate for STCG varies because the gains are first added to an individual’s regular income, then taxed as per the income tax slab they fall under.)
Things are changing now as the former ‘hard nut to crack’ market is pretty accessible by pre-IPO funds, employee stock options (ESOPs), and us!
Pre-IPO funds -
- Pre-IPO funds are registered under category 2 of Alternative Investment Funds (AIF) regulated by the Securities and Exchange Board of India (SEBI).
- The minimum investment amount is one crore INR.
- These funds are always offered under Close- Ended Fund Scheme.
Employee Stock Option Plans (ESOPs)
- ESOPs are an option under which company shares are offered at a discount to the market price to company employees instead of paying high salaries.
- Taxation of ESOPs is executed by the Finance Act, 2009, according to which tax application arises at two stages from the employee’s perspective:
Stage 1: Share allotment to the employees
This stage discusses the difference between FMV & the Exercise price of a share, also referred to as ‘perquisite’.
It is governed by Rule 3(8) of Income Tax Rules, 1961, amended in Union Budget 2020.
According to the recent amendment made to the rule as mentioned above in Union Budget, 2020, ‘perquisite’ or the difference between FMV and the exercise price of the share as per the ESOP document will be taxed at the source on earlier of the following three events,
- Completion of 5 years from ESOP allotment
- Upon the sale of shares allotted under ESOP,
- On the resignation date
Stage 2: Sale of shares by the employees
Upon the sale of shares allotted under the ESOP scheme, an employee is liable to pay capital gains tax according to the duration for which the shares were held.
LTCG — It is applicable when shares are held for more than 24 months from the date of allotment. The capital gains are taxed at 20% with indexation benefits as per section 112 of the Income Tax Act, 1961.
STCG applies when shares are held for less than or equal to 24 months from the date of allotment. The short-term capital gains are first added to employees’ regular income, after which they are taxed per the employee’s tax slab.
How are capital gains computed for taxation purposes?
Let’s learn this with an example.
Imagine there are two investors, John & Alex.
Background of John.
John is an individual with a business income. He has bought 1,000 unlisted shares of XYZ Pvt. Ltd for 20 INR on Jan 1, 2019. Now, as the price of unlisted shares from XYZ Pvt. Ltd has increased to 50 INR as of Jan 1, 2021; he plans to sell them.
Background of Alex.
Alex is a salaried employee with no business income. However, he bought 500 shares of the same company for 10 INR on Jan 10, 2017. Now, as the price of unlisted shares from XYZ Pvt. Ltd has increased to 50 INR as of Jan 1, 2021; he plans to sell them.
Inflation in the Indian economy is assumed to be 5%.
Information to care about for calculation of capital gains.
Before we get into the calculations, here is a question that you need to answer first.
For what type of capital gains do John & Alex qualify for, respectively?
Answers.
A) John held his investment for 24 months. Therefore, the gains from the investment made in XYZ Pvt. Ltd qualifies as Short-Term Capital Gains (STCG).
B)Alex held his investment for 36 months. Therefore, the gains from investment in XYZ Pvt. Ltd qualifies as Long Term Capital Gains (LTCG).
How will they be taxed?
Answers.
A) As John’s investment qualified as STCG, the gains of 30,000 INR will be added to his regular income. Following this, he will be taxed according to the tax slab he falls under.
B) Alex’s investment qualified as LTCG. Therefore, we need first to adjust the purchase price for indexation benefit.
Cost of acquisition in 2017 = price of one share* no. of shares
= 10 INR * 500
= 5,000 INR
Adjusted cost of acquisition = Cost of acquisition + ( cost of acquisition* inflation)
= 5,000 + (5000* 6%)
= 5,000 + 300
= 5,300 INR
Capital gains for Alex
Total selling price= Selling price for one share * no. of shares
= 50 INR * 500
= 25,000 INR
Taxable Amount = Total selling price — The adjusted cost of acquisition
= 25,000 INR — 5300 INR
= 19,700 INR
LTCG = Taxable Amount * tax rate
= 19,700 * 20%
= 3,940 INR
Therefore, Alex is supposed to pay 3,940 INR as per the norms of LTCG.
Which Income Tax Return form are they supposed to fill out?
I will tell you something before I answer the question.
As you may be aware, seven different ITR forms have been categorized based on your income source. How much is your income? Are you an individual? Or HUF? Or a company?
Told you! Precize works to make its readers stand out from the rest of the world.
Well, let’s continue.
So, please scroll up a bit to the section where I discussed the background of John and Alex. If you pay attention to the first line of the respective background section, you will notice that John has a business income; on the other hand, Alex is a salaried employee.
But why does it matter? It matters because this difference between the source of income will make them fill out different ITR forms.
CASE 1: John
Since John has business income and investments in private equity shares, he is supposed to fill ITR (3).
CASE 2: Alex
Since Alex has no business income and investments in private equity shares, he is supposed to fill in ITR (2).
What happens if investment in private equity shares results in a loss?
- If an investment held for more than 24 months results in a loss, it is referred to as a long-term capital loss. This type of loss can only be set off against long-term capital gains, if any, from any other investment.
- If an investment held for less than or equal to 24 months results in a loss, it is called a short-term capital loss. This loss can be offset against long-term capital gains and short-term capital gains from any other investment.
What legalities are involved when transferring private equity shares from the buyer to the seller?
As you already know, we need to consider two types of prices for private equity shares: FMV and sale Consideration.
Case 1: When Sale consideration < Fair Market Value (FMV)
If the trade of private equity shares is executed below the Fair Market Value of such shares, the FMV is considered for calculating capital gains as per section 50CA of the Income Tax Act, 1961.
Case 2: When Sale Consideration >= Fair Market Value (FMV)
Suppose the trade of private equity shares is executed above or at a price equal to Fair Market Value. In that case, sale consideration is considered the actual buy price for private equity shares, and section 50CA of the Income Tax Act, 1961, is not applicable anymore.
Lastly, what is the lock-in period?
The lock-in on pre-IPO shareholding of non-promoters is six months.
