Global depository receipts: Clarity is missing

After the announcement by the Finance Minister in the last year’s speech about liberalizing Global Depository Receipts (‘GDR’) scheme, the Finance Ministry had notified the new Depository Receipt Scheme, 2014 in December 15, 2014. 

The earlier scheme was limited to issue of GDRs based on underlying shares of the company sponsoring the GDRs where the company was listed or was to be listed simultaneously. As per the new scheme, GDRs can be issued against underlying securities which can be debt instruments, shares, units, etc and the issuing company can be listed, unlisted or private or public companies. Further any person holding securities can tender securities in the process of issuance of GDRs.

The scheme was framed as per the recommendations of the Sahoo committee, which had also made suggestions about the taxation of GDR in its report, but the scheme adopted only the regulatory recommendations of Sahoo committee. 

The tax aspects of the GDRs were therefore shrouded in uncertainty. Clarification on these aspects was expected in this budget but the proposed changes in law fall short of investor community’s expectations.

To briefly touch upon the tax background, currently tax law provides for taxation of capital gains from transfer of GDRs at the rate of 10% under section 115AC. Further, conversion of GDR to shares and the transfer of GDR outside India between two non-residents are treated as not taxable under the earlier scheme. The Scheme introduced in 1993 made a specific mention of the taxation of GDR. It provided for adoption of market value of underlying shares on conversion for computing capital gains on sale of shares on the stock exchange. However, the new scheme does not mention about the tax aspects. The earlier scheme has been repealed except to the extent relating to FCCBs. This creates a lacuna. It was expected that this lacuna will be addressed in the budget.

Further, there is disparity as compared to concessional tax treatment that is available to investors in shares.  Long term capital gains are exempt from tax in case of sale of equity shares traded on stock exchange and on which securities transaction tax is paid. Short term gains are taxed at 15%. However, long term capital gain arising from sale of underlying shares in a domestic tender offer (by resident or non-resident shareholders) under a the DR scheme is taxed @ 10% and short term capital gains at  30%. This disparity has not been addressed despite recommendation by the Sahoo Committee.

Further, exemption from capital gains tax on conversion of GDRs to shares was expected to be extended to the conversion of the securities into GDRs (in case of non-resident investors). This has been left untouched. 

Similarly the practice of adopting market value of conversion as cost for computing capital gains on sale of shares (as provided in the earlier scheme), was expected to be codified specifically in the law. It appears that the foreign investor community would have to continue to rely on the past practice on tax treatment for any exits on the local markets.

It was also expected that the existing tax laws would be aligned with the scheme to extend the definition of GDR to cover new classes of assets other than equity shares, and also to cover unlisted and private companies. 

The definition of GDRs is proposed to be amended to cover only GDRs issued against the issue of shares of a listed company. The explanatory memorandum states that the tax benefits were intended to be provided only to sponsored GDRs of listed companies. This will have the effect of restricting the tax exemptions discussed above (offshore transfers and conversions) only to sponsored issues.

(Sunil Gidwani is a partner while Siddharth Ajmera is manager, PwC – Tax and Regulatory Services, Mumbai).

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