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Puneet Shah and Manas Daga, IC Universal Legal

In order to streamline the mode of stamp duty collection and to rationalise the stamp duty levy on securities transactions across the country, the Ministry of Finance introduced certain amendments to the Indian Stamp Act, 1899 late last year.

Initially, the amendments were proposed to be implemented from January 9, 2020. However, this was postponed to April 1 and thereafter to July 1 due to the coronavirus pandemic. The amendments finally came into effect on July 1.

The amendments seek to implement uniform stamp duty across the nation on sale, transfer and issue of securities. This minimises the cost of collection and avoids multiple incidents of stamp duty levy.

The amendments appoint the stock exchanges, clearing corporations, registrar to an issue, share transfer agents and depositories as authorised agencies for collecting stamp duty on securities transactions. 

Until now, units issued by alternative investment funds (AIFs) were not considered as ‘securities’ and, therefore, no stamp duty was payable on their sale, transfer or issuance.

As an industry practice, and particularly taking cue from mutual funds, the fund managers of AIF have always issued a ‘statement of account’ (SOA) which specifies the number of units held by the investors.

The SOA, although being a record of rights, had never been considered as an ‘instrument’ for levy of stamp duty under the Stamp Act and was more seen as a procedural step towards establishing a right and, therefore, not subject to stamp duty.

New rules now provide for levy of stamp duty on an instrument (whether electronic or otherwise) of transaction in ‘securities’. The term ‘securities’ has been defined to mean and include shares, debentures, bonds, derivatives, units of collective investment scheme and units of mutual funds, amongst others.

However, units issued by an AIF, an investment pooling vehicle, to its set of investors has not been explicitly included in the definition of term ‘securities’. This led to ambiguity in the investment fund industry about the applicability of the proposed amendment and thereby imposition of stamp duty on the sale, transfer or issue of AIF units with effect from July 1 which till now were always recorded and transacted in the form of an SOA. 

Nevertheless, the Securities and Exchange Board of India (SEBI) on June 30 clarified that stamp duty will be levied on the sale, transfer or issue of AIF units even if transacted in the SOA form. SEBI didn’t get into the debate if AIF units indeed are covered in the definition of ‘securities’ and has kept this issue open for interpretation by the industry.

The amendments provide that issuance of AIF units would attract stamp duty at the rate of 0.005% of the market value. Any transfer of AIF units would attract stamp duty at the rate of 0.015% of the consideration amount.

SEBI has not specifically clarified if the redemption of AIF units will attract any stamp duty. However, inference can be made from a SEBI clarification letter dated June 29 read with frequently asked questions issued by the regulator stating that redemption of mutual fund units is neither a sale nor a transfer or issue of securities and, therefore, should not attract stamp duty. The same principles should also apply to redemption of AIF units.

Besides, the SEBI circular now requires AIFs to mandatorily appoint an RTA for the collection of stamp duty within 15 days on or before July 15, 2020. This will certainly increase the cost of AIF operations and management and will, in turn, affect the return to AIF investors negatively.

AIFs should have been offered some breathing time to align with the new rules as unlike mutual funds, transfer and redemption of AIF units, particularly for those which invest in the unlisted space, is not so frequent. This eliminates the operational requirement to have a full-time RTA for AIFs only for the purpose of stamp duty collection. 

SEBI regulations governing the AIF operations also prescribe the minimum capital contribution of Rs 1 crore from each AIF investor. The stamp duty levy on issuance of AIF units will put additional costs on the investors. It will ultimately reduce their invested capital or net amount available for investment and, therefore, impact the return.

In order to efficiently manage the funds and provide better returns to the investors, the fund managers follow a multiple closing format whereby they keep on drawing funds from the investors depending on the requirement for their portfolio investment. Therefore, AIF investors are required to contribute a certain agreed portion of capital commitment to the AIF at each drawdown and the AIF issues units with respect to each such contribution. The levy of stamp duty at each such drawdown may cause operational difficulties to the investment manager. 

Incidentally, SEBI regulations governing the AIF operations also require category I and II AIFs to undertake valuation of their investments once every six months (this can be extended to one year with the requisite investors’ consent) by an independent valuer. Since, the stamp duty levy is on the market value of units, it would be practically difficult to determine the market value of AIF units at the each issue, transfer and sale event considering that the valuation benchmark would be available only bi-annually or annually, as the case may be.

Based on the performance of the AIF fund and its underlying portfolio, the market value of the units may vary from its face value. Therefore, stamp duty determination on the units to be issued to the subsequent investors of investment funds may pose a serious challenge to the fund managers.

Unlike mutual funds, which primarily invest in listed companies, the AIFs—particularly in category I and II—invest in unlisted, illiquid securities. Therefore, frequent valuation and price discovery of AIF units for stamp duty determination on the basis of the underlying unlisted portfolio of these AIFs is too cumbersome and subjective.    

Needless to say that issuance of securities has always been a state subject and the union list did not have power to specify rates of stamp duty in respect of issue of securities. New rules of stamp duty, therefore, would require the respective states such as Maharashtra and Karnataka, which are epicentre of these AIFs and from where the AIF units will be issued, to necessarily amend the state-specific stamp duty laws. 

These amendments will certainly promote ease of doing business and will boost the government revenues multi-fold due to voluminous and high-value securities transactions which are being made subject matter of stamp duty levy.

However, there are several practical challenges which the investment fund industry in particular is facing. These would need to be addressed on priority for the effective implementation of these new rules of engagement.

Puneet Shah is a Partner and Manas Daga is an Associate at IC Universal Legal, Mumbai. Views are personal.

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