Tax Implications of Acquiring a Company Through Purchase of shares in the Context of an Unlisted Company.

In India, acquiring a company by purchasing 100% of its shares is a common practice, especially for new ventures seeking to gain control over an established business.

This arrangement is often pursued to leverage the existing company's reputation, client base, and eligibility to participate in tenders. However, amidst the excitement of such a business deal, entrepreneurs frequently overlook the crucial aspect of tax implications.

One significant consideration is the ‘capital gains tax’ that may arise for the transferor of the shares.

In this article, we will explore the tax implications of acquiring a company through share purchase.

 

Capital Gains Tax:

When shares of a company are sold, the gains derived from the transfer are subject to capital gains tax. The Capital gain is the excess of the consideration received towards the transfer of shares over the cost of acquisition of those shares.

a)    Sale Consideration            XXXXX

b)   Less: Cost of Acquisition  XXXXX      

Capital Gain                     XXXXX

 

The tax liability arises for the transferor, i.e., the seller of the shares, and the rate of tax depends on the holding period of those shares.

1. Short-term Capital Gains:

If the shares are held for a period of lesser than 24 months before their transfer, the resulting gains are considered short-term capital gains (STCG). STCG is added to the individual's taxable income and taxed at the applicable income tax slab rates.

 

2. Long-term Capital Gains:

If the shares are held for a period of 24 months or more, the resulting gains are considered long-term capital gains (LTCG). LTCG on the transfer of shares of unlisted companies is taxed at a rate of 20% with an indexation benefit.

Indexation allows taxpayers to adjust the cost of an asset for inflation when calculating capital gains tax.

To calculate the indexed cost of acquisition, the following formula is used:

Indexed Cost of Acquisition = Cost of Acquisition × (CII of the Year of Transfer / CII of the Year of Acquisition)

Tax Planning Considerations:

To minimize the impact of capital gains tax while acquiring a company, entrepreneurs can consider a few tax planning strategies:

1. Holding Period:

If the buyer intends to acquire a company and subsequently sell it, they can plan the holding period strategically. Holding the shares for at least 24 months would qualify for the lower tax rate of 20% with indexation benefits.

2. Seek Expert Advice:

Engaging the services of tax professionals and experts in mergers and acquisitions can provide valuable guidance on structuring the deal to optimize tax benefits. They can analyze the specific situation and recommend tax-efficient strategies.

 

                                 While acquiring a company through share purchase in India offers numerous advantages for new ventures, it is essential to consider the tax implications involved.

Entrepreneurs should carefully plan the transaction, taking into account the holding period, structuring options, and seeking professional advice.