Tax liability attached to a demutualized stock exchange

When a trading right is acquired, and a share is allotted to a member of an stock exchange by virtue of which he acquires a membership privilege against the extinguishment of the previous right of membership, no transfer of assets effectively takes place and neither of the acquisitions should therefore be deemed to be a transfer within the meaning of the word in the Income Tax Act. However, at the point of sale of any of these two rights, capital gains tax would be attracted.

Since the above processes are necessary to implement a policy announced by the Government, and in the larger interests of the securities market in India as well as in the interests of investors, it would be necessary to ensure that both the processes described above are tax neutral and no additional tax liability is attached either to the stock exchange or to a member of a stock exchange which is implementing an approved scheme of demutualization. Such tax neutrality was essential to nudge the process of corporatization and demutualization and it would not be fair to the stock exchanges and the members, nor will they be encouraged to expedite the implementation of demutualization, if such neutrality was not provided.

The Income Tax Act has already made some provisions to facilitate the corporatization of stock exchanges in India by way of the Finance Act, 2001 under which clause (xiii) of Section 47 of the Income Tax Act was amended to provide that any transfer of capital asset from an association of persons, for a body or individual under the scheme of corporatization of a recognized stock exchange shall not be regarded as transfer for the purposes of capital gains tax. The proviso to clause (xiii) has also been amended to provide that this one time exemption from capital gains tax is available only if all the assets and liabilities of the stock exchange immediately before the succession become assets and liabilities of the corporatized stock exchange, and the scheme of corporatization is approved by the SEBI.

In effect, the Finance Act has made three amendments, 2001, in clause (xiii) of Section 47, which has taken effect from April 01, 2002. Their effect is to indicate that the corporatization of a recognized stock exchange in accordance with a scheme approved by the SEBI will not be a “transfer”. This would be even if there is a transfer of capital assets or intangible assets from the stock exchange which was originally a firm or an association of persons to the stock exchange when it becomes a company under the approved scheme.

This shall ensure that the past profits of a stock exchange which were not taxed when it had the character of a not for profit entity should not be taxed when its character changes. In other words, the accumulated reserves of the stock exchange as on the day of corporatization should not be taxed. However, there would be no objection to taxation of these reserves, in the hands of the shareholders when these are distributed to shareholders as dividend at the net applicable tax rate; equally all future profits of the stock exchange after it becomes a for profit company may be taxed.

Moreover there are necessary provisions that are being made in the Indian Stamp Act and the Sales Tax laws to exempt from stamp duty and sales tax, the transfer of the assets from the mutual stock exchange and the issuance of shares by the new demutualised for-profit company, formed pursuant to an approved scheme of demutualization;

The next question is why to demutualize the stock exchanges. The recent transformations in the global environment have added new dimensions to the trading, clearing/settlement and listing functions of SEs. Many of these functions have been come under actual or potential competitive threat. The need to meet the demand from its customers for lower transaction costs; more efficient services and new products are now become more crucial for the survival of SEs. The driving forces behind demutualization are found to be growing competition among SEs, increasing listing of global companies.

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