Going Public: Learning about IPOs and its Income Tax and Companies Act Provisions

Arjuna (Fictional Character): Krishna, the Tata Technologies IPO has created a buzz in the financial markets. The taxpayers are very eager to know more about the concept of IPO, so please shed light on the same.

Krishna (Fictional Character): Arjuna, IPO stands for Initial Public Offering. It's a company’s grand entrance to the stock market. Through IPO a closely held company offers the public for the very first time a part of its share capital through the issue of shares. After the IPO, the company becomes "public," and anyone can buy or sell its shares on the stock exchange the company gets listed on. 

The issue of shares by the company shall be subscribed at least 90%, or else the issue is considered as a failure and the company is required to refund the amount raised by it. The recent IPO of Tata Technologies was oversubscribed by 70 times, which that means for every share the company offered, the company received 70 applications.

Arjuna (Fictional Character): Krishna, how is the transfer of these shares taxed under the Income Tax Act, 1961?

Krishna (Fictional Character): Arjuna, if the subscriber is allotted shares under IPO, he will not be taxed under income tax for listing gains that he may get from such an issue. However, if one decides to sell such acquired shares only then does the taxability under the Income Tax Act come into play. The taxability on the transfer of such shares depends on the period of holding of shares. If a taxpayer holds listed shares for a period of more than 12 months before their sale then the transfer would be treated as a long-term transfer and if the period of holding is less than 12 months, the transfer would be considered a short-term transfer.

Short Term Gain on transfer of shares is taxed at the rate of 15%, whereas long-term gain on transfer of listed shares is taxed at the rate of 10% on gain above Rs. 1,00,000. Thus, we can understand that long-term capital gain up to Rs. 1,00,000 is exempt under income tax.

Arjuna (Fictional Character): Krishna, What are the major companies act related provisions for IPO?

Krishna (Fictional Character): Arjuna, the companies are firstly required to get approval from the existing shareholders for the issue of shares to the public. The companies are also required to issue a Red Herring Prospectus, which contains all the details of the company and the issue of shares. The company is required to maintain a separate bank account for such money raised. As discussed above, 90% of the total issue must at least be subscribed, or else the issue is considered as a failure.

In addition to the provisions of the Companies Act, 2013 the companies are required to follow the guidelines and rules set out by SEBI.

Arjuna (Fictional Character): Krishna, what should one learn from this?

Krishna (Fictional Character): Arjuna, the companies issues shares through IPOs to fuel their growth ambitions. The company however needs to make sure it uses the raised funds only for the objectives that were put forward in the prospectus issued. The companies' managements are also required to be careful and cautious in valuing their company as under subscription of shares could force the company to return the raised money. The taxpayers shall also study various aspects of the company before applying for IPOs and shall align their investment with their vision and growth strategies. With regard to taxation on the transfer of such sales, well it all depends on the duration the taxpayers hold the shares.