Unicorn IPOs may Bring Tax Woes for Early Investors

Some of the large investors in unicorns that are being listed on the capital markets could face tax complications on the issuance of bonus shares and may end up coughing capital gains tax sans grandfathering benefit.

Early investors in unicorns such as Paytm, Mobikwik, PolicyBazaar and Zomato could face between 10% and 15% tax on the bonus issue of shares.

Investors will have to cough up millions on their realized gains, say tax experts.

Prior to getting listed unicorns have to bring down the per share price, so that small retail investors can participate in the issuance. The only way to do so is to issue bonus shares- a step that may not be protected fresh issuance, say tax experts.

“Many large investors in the companies that are going for IPOs are set to face long-term and short-term capital gains tax and may not be able to take tax treaty benefits of grandfathering,” said Girish Vanvari, founder of tax advisory firm Transaction Square.

“In most cases, companies have issued bonus shares to bring share prices lower when they get listed, and this issuance even to existing foreign investors will be treated as a fresh issue of shares and will be taxable despite the old treaty grandfathering.”

A grandfathering clause is a provision in tax laws in which an old regulation continues to apply to some existing situation while a new rule will apply to all future cases.

India amended tax treaties- Double Tax Avoidance Agreement (DTAA)- with Singapore and Mauritius in 2016 and 2019, respectively. Unlike the older ones, the new tax treaties inserted short-term capital gains tax at 15% and10%.

While amending the tax treaties, however, India allowed grandfathering benefits. That is any investment made prior to a cut-off date will be treated as if it was made under old tax treaties. “The grandfathering date for capital gains tax provisions on listed companies under domestic tax law is 31 January 2018,” said Sudhir Kapadia, national leader tax at EY in India. “Thus, for bonus shares issued by a listed company on or after 1 February 2018, the current capital gains tax provision will be applicable (tax on long-term capital gains 10%).”

Paytm and Zomato have some of the marquee investors. Paytm has investors like China’s Alibaba, Masayoshi Son-led Soft- Bank Vision Fund and SAIF Partners (now Elevation Capital). While Zomato has investors like Tiger Global, Temasek, Baillie Gifford and several others.

Most of the investors in unicorns are based in two Destinations-Mauritius and Singapore. This structuring was mainly done as part of the tax planning and to avoid any complications in taxation arising in India.

And this is what is set to hit all the invertors in unicorns that are getting listed. Even in cases where no fresh investment is made but merely shares are split and received, the new tax treaty would apply, say tax experts.

Which is to say that assuming an investor invested in a unicorn in 2015 and the per share price is about Rs. 10,000. In 2021, the per share price at which it can hit the capital markets.

So, a capitalization table is created and shares are split-by issuing bonus shares. Let’s assume the new share price arrived is Rs. 50 for an IPO.

After this exercise, the number of shares held by the investors will go up tremendously.

In an ideal situation had the investor sold the shares at Rs. 25,000 there would be no tax on Rs. 15,000 appreciations as the gains will be grandfathered. Not anymore because now bonus shares are issue, which are treated as fresh issuance, say tax experts. S-ET

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