Tax Implications on Income from IPO Gains

A new buzzword in the world of security investment is IPO. Initial public offer or popularly called IPO, is the process whereby the shares of a private limited company is sold in the market, open to public investors for the first time. When the shares are sold for the first time in the market, it is termed as the primary market. So, an IPO essentially involves trading of shares in the primary market. In recent times, there has been a surge in IPO investments. India has experienced a 140% increase in the volume of IPO funds raised in the year 2024, as compared to the previous period. Therefore, the tax implications on IPO transactions are growing more relevant than ever.

While there are ways to raise funding through an IPO without listing shares in a stock exchange (NSE and BSE in India), it is raised predominantly through listing securities in a recognized stock exchange. The tax implications differ according to the company's mode of fundraising.

How IPOs Are Taxed - Key Considerations:

The capital gain implications of an IPO are similar to those of the capital gain taxation of shares, which varies according to the period of holding and listing status.

Key points to be considered for the transfer of shares acquired in case of an IPO:

1. Period of holding: Capital gain implications vary accordingly, so does the exemption availability.
2. Security type: There can be IPOs for equity shares or debt securities. Capital gain implications vary accordingly.
3. Payment of STT in case of equity share transfer.
4. Date of transfer

Understanding capital gains tax on IPO investments:

Capital gain implications on the sale of:

1. Listed equity shares floated as IPO :
   1. Holding period: If the shares are held for a period exceeding 12 months, they are considered a long-term capital asset, the eventual transfer of which will result in long-term capital gains. This means that even when held for a period equal to 12 months, they are still a short-term capital asset.
   2. Rate: The rate determination depends on the date of transfer as per the amendments in budget 2024.

If the transfer happens on or after 23/07/2024:
i. In the case of short-term capital gains – 20%
ii. In the case of long-term capital gains – 12.5%

If the transfer has happened before 23/07/2024:  
iii. In the case of short-term capital gains – 15%
iv. In the case of long-term capital gains – 10%

           3. Exemption availability:

i. In the case of long-term capital gains the exemption of Rs.1,25,000 is available. The exemption can be availed for capital gains earned throughout the financial year 2024-25
ii. In the case of short-term capital gains, no exemptions are available.

   4. Indexation benefit: In any of the above cases, indexation benefit is not available.

  2. In case of debt IPO:

a. Holding period: If the shares are held for a period exceeding 12 months, they are considered a long-term capital asset, the eventual transfer of which will result in long-term capital gains. This means that even when held for a period equal to 12 months, they are still a short-term capital asset.

b.  Rate: The rate determination depends on the date of transfer as per the amendments in budget 2024

If the transfer happens on or after 23/07/2024:
i.      In the case of short-term capital gains – As per slab rates
ii.      In the case of long-term capital gains – 12.5% without indexation

If the transfer has happened before 23/07/2024:
iii.      In the case of short-term capital gains – As per slab rates
iv.      In the case of long-term capital gains – 20% with indexation benefit 

Is that necessary to pay capital gains tax on subscription?

It is to be noted that no tax implications arise at the time of subscription or purchase of IPOs in the hands of the investor. The very nature of capital gains taxation is that it arises at the time of sale/ transfer.

Taxation of Stock Options and Employee Equity in IPOs:

In the case of employee stock options given at the time of IPO, the capital gains provisions do not differ per se, but a few details are to be looked into regarding the date of acquisition, and period of holding.
In the case of an ESOP, the employer agrees to provide the ESOP to the employee upon satisfaction of vesting conditions. Vesting conditions normally involve remaining in the employment term for a specified period of time. Other conditions may also be satisfied, which differ on a case-to-case basis.
Only when the vesting conditions are fulfilled, and the option to purchase is exercised is the ESOP acquired by the assessee. So, the date of exercising the option becomes the date of acquisition, using which the period of holding is calculated.
Also, when purchasing ESOPs, employees receive the shares at a concessional rate compared to the market price. Since this concessional amount results from employment, it is treated as perquisites under salary in the year of acquisition. 

Tax Responsibilities for Companies Going Public:

IPO shares are mostly issued at a premium. As per the provisions of section 56(2)(viii), when a closely held company (private limited companies and unlisted public companies) issues shares at a premium, the premium is taxable as income from other sources.
For the purpose of understanding excess premium – here it means premium exceeding the fair market value of shares. So, in case their issue price exceeds the face value but is still less than or equal to the fair market value, tax implication u/s 56(2)(viib) does not arise.
The above provision is not applicable to:

1. Start-ups that have a sum of paid-up share capital and securities premium within Rs. 25 crores after the issue of shares.
2. The consideration is received by a venture capital fund venture capital company or venture capital undertaking or category I and II of Alternative investment fund.

Strategies to minimize tax after IPOs:

1. The period of holding can be extended to greater than 24 months so that it becomes a long-term capital gain, for which tax is lesser than short-term capital gains. Also, an exemption of Rs.1,25,000 is available in such cases.
2. In the case of the sale of listed equity shares or equity-oriented funds acquired before 01-02-2018, grandfathering provisions become applicable. In such instances, the fair market value as of 31.01.2018 can be claimed as the cost of acquisition if it is beneficial. In any case, the deduction claimed shall not exceed the sale value of shares.
3. The set-off of long-term capital losses is available only against LTCG u/s 112A. However, short-term capital losses can be set off against both LTCG and STCG. The above provisions are the same in case of inter-head adjustments in the current year or set-off of carried forwarded losses.
4. In the case of individuals and HUFs, when total income minus long-term capital gains falls below the basic exemption limit, the figure (Basic exemption limit)—(total income minus LTCG) can be claimed as a deduction. This is called exhaustion of the basic exemption limit.

Common mistakes to avoid during an IPO:

1. Choosing an incorrect ITR form may result in defective returns, which may result in unwanted additional compliances.
2. The capital gains must be as per the figures mentioned in the Annual Information Statement. If there is an inconsistency between the capital gains statement available to you and AIS, it is recommended that you raise online feedback following prescribed procedures.
3. Apart from mistakes that result in tax implications, it is generally better to do proper research and invest and do fundamental analysis before investing instead of following the trend.