The record date for the merger of HDFC Ltd with HDFC Bank was 13 July. The record date is the cut-off date set by a company to determine the eligibility of shareholders to receive dividends and distributions. As per the share exchange ratio of the merger, for every 25 shares of HDFC, 42 shares of HDFC Bank were issued to the former’s shareholders. If we break this down to per share level, one can say that the ratio is 1.68 shares of HDFC Bank for every 1 share of HDFC.
Shares are considered capital assets under income tax (IT) law, and any gain on their sale is treated as capital gains. However, in the case of a merger, the IT law does not consider the swap of shares as a transfer, ensuring that it is tax-neutral for shareholders. To qualify for this tax-neutral benefit, the merger must meet certain criteria. First, all assets and liabilities of the amalgamating company must be transferred to the amalgamated company. Second, a minimum of 75% of shareholders (in value) of the amalgamating company must become shareholders of the amalgamated company. The case of HDFC Bank qualifies for both of these conditions.
Capital gains on sale of shares is calculated on the basis of the holding period and the date of acquisition of shares. If someone receives shares as part of a merger, the holding period is counted from the date of purchase of the amalgamating company’s shares (HDFC Ltd in this case).
Let’s understand this with an example. Suppose you bought 30 shares of HDFC Ltd on 1 April 2019 at ₹2,000 per share, thus spending ₹60,000. As per the share exchange ratio upon merger, you are entitled to receive 50.4 (42/25*30) shares of HDFC Bank. But since there is no concept of fractional shares in India, you will be issued 50 shares of HDFC Bank. Further, as per the Bank’s BSE announcement of 14 July, the share allotment exercise has been done and the listing of these shares is under process.
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Now, let’s assume these 50 shares of HDFC Bank are listed on the exchanges on 17 July at ₹1,700 per share. Further, assume you sell these 50 shares on 1 August for ₹1,800 per share which makes the total sales consideration to be ₹90,000. This sale transaction will be subject to capital gains tax.
In the case of listed companies, equity shares held for more than 12 months are classified as long-term capital assets, while those held for a shorter period are classified as short-term capital assets. In the above example, the holding period is from 1 April 2019 to 1 August, making the gains long-term capital gains.
The cost of purchase of shares of HDFC Ltd will be taken to be the cost of purchase of shares of the HDFC Bank (amalgamated company). In this example, the cost of purchase of 50 shares of HDFC Bank received on merger shall be ₹59,524 ( ₹60,000/50.4*50). This adjustment to the cost of purchase is done as against the original cost of HDFC Ltd share entitlement of 50.4 shares. Accordingly, there will be a long-term capital gain of ₹30,476 ( ₹90,000- ₹59,524). One important thing to note here is that the benefit of grandfathering will also be available in cases where shares of the amalgamating company were purchased on or before 31 January 2018.
As for the 0.4 fractional entitlement, since it will not be given as a share, the shareholder will be paid consideration in cash or kind. This will be taxed as capital gains as the shareholder has not received shares in lieu of shares and so, unlike the swap of shares on a merger, no tax benefit is given here. In our example, your fractional entitlement was 0.4 shares. Let’s assume that on the day you are paid for the fractional entitlement, the value of 1 share of HDFC Bank was ₹1,820. The capital gain on the fractional entitlement will be the value of 0.4 shares, i.e. ₹728 ( ₹1,820*0.4) as reduced by the cost of purchase, i.e. ₹476 ( ₹60,000/50.4*0.4) which comes out to be ₹252. Rules of the holding period to classify it as long-term or short-term will apply as mentioned above.
Sambhav Daga is partner at Sunil Johri & Associates
Updated: 16 Jul 2023, 10:26 PM IST