Wed, Apr 30 2014.

06 17 PM IST
Shyamal Banerjee/Mint
Tax benefit from loss-making shares
If market value falls below cost, the shares are valued at the market value
Gautam Nayak
I was recently surprised to receive an open offer for purchase of
shares of a listed company, which has been in liquidation for the past
few years. A large fraud in the overseas parent company, with
consequent liquidation of that company, had resulted in the Indian
subsidiary company also being liquidated. From the reports of the
liquidator, which were received every year, it appeared that most of the
assets had been sold off and there would be hardly any money left for
the shareholders, and therefore, I had reconciled to a complete
write-off of the investment.
The open offer was also for less than a rupee per share, and
therefore, the amount to be received under the open offer on tender of
my shares would be a few hundred rupees. This would barely
compensate me for the effort involved in tendering the shares under
the open offer. So, my first reaction was to just throw the open offer
documents into the dustbin. However, my tax instincts made me
reconsider my options.
If I tendered my shares under the open offer, it would be regarded as a transfer of the shares. Though the shares are long-term capital assets
(I had held them for several years), since they are being sold off the market in a transaction that is not subject to securities transaction tax, the
gains and losses on the transaction are not exempt from tax. Since my cost of acquisition almost a decade ago was a few thousand rupees, I
would be incurring a loss on sale of the shares. Since the shares are long-term capital assets, I would also be getting the benefit of indexation
of cost from the year of purchase.
In all, I would get a substantial long-term capital loss for tax purposes on sale of my shares.
I can set off this long-term capital loss against any other long-term capital gain that I may make, which is not exempt from tax. Such gains
could include gains on sale of property, gains on sale of shares under a buy back or open offer, or even gains arising from redemption of my
fixed maturity plan mutual fund units. The benefit of the set-off would not only be available for the current year, but can also be carried forward
for eight years.
What is the alternative? If I continue to hold the shares, I would not be realizing my loss, and therefore, though I have suffered a loss of capital,
such a loss would not be recognized for tax purposes. If the company were to ultimately liquidate, it is only then that I would be able to get the
benefit of claiming a capital loss in respect of the shares. That may take a few years more, or it could be that the new management chooses to
continue with the company rather than liquidate it, in which case, the liquidation may not happen in the foreseeable future.
Under tax laws, no gain or loss in respect of a capital asset can be recognized unless there is a transfer of the capital asset. A transfer takes
place either when there is a sale, or buy back of the shares or liquidation of the company. It is only at this point of time that any gain or loss can
be recognized.
A trader in shares can, however, claim the benefit of a loss in the value of shares as and when it occurs, because the business profits from the
business of trading in shares is to be computed by factoring in the value of the closing stock of shares, which can be valued at the lower of the
cost or the market value. Therefore, if the market value falls below cost, the shares are valued at the market value, enabling a claim for set-off
of the fall in value of the shares against other income.
However, in my case, having held the shares for several years as capital assets, obviously I cannot convert the shares of a company
undergoing liquidation into my stock in trade and claim to be dealing in those shares, particularly when those shares are not traded on the
exchange.
Of course, before taking any decision, I also need to consider the likelihood of appreciation in the value of the shares under the new
management. Given the fact that all the assets of the company have been sold and the fact that the new promoters are unknown individuals,
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that would be a leap in the dark.
Can the tax authorities claim that my sale of shares is actuated only by tax considerations, and so I should be denied the benefit of the capital
loss? Under current tax laws, in the absence of applicability of the General Anti-Avoidance Rules, such a stand would be totally untenable.
If every action that is actuated by tax considerations can be declared null and void, then every investment in Public Provident Fund or National
Savings Certificates could be challenged on the ground that such investments were actuated only by tax considerations.
I have, therefore, decided to tender my shares in the open offer, and hope and pray that the benefit of the capital loss would be available to me!
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