Does promoters’ share sale result in business income?

Punjab and Harayana High Court in the recent case of Sumeet Taneja v CIT has held that the transfer of shares by the promoters is a transfer of business and taxable under the head business income and not capital gains. This decision adversely affects promoters who incorporate companies and have a substantial shareholding in such companies, since on the transfer of such a shareholding, following the above ruling, they could be taxed at 30% rather than at 20%.

Court’s findings

The high court observed that there was no innocent transfer of shares, to be treated as a transfer of a capital asset, but a transfer of business with all pervasive control being entrusted to the purchaser for complete and absolute exclusion of the seller whether as a shareholder or for management and control of the business. Thus, there had been a transfer of the management of the company. In addition to the transfer of shares, the seller also had to hand over the databases, employees, etc., to the purchaser. Moreover, the seller had agreed not to carry on business in a similar field for a certain period.

When promoters transfer shares, there is a transfer of their controlling interest also. The characterization of the assets which are subject to transfer determines the taxability in the hands of the promoter. If treated as business income, there is taxability at a higher rate, which adversely affects the tax position of the promoters.

Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune, Ahmedabad, Bengaluru and Chennai. Pranay Bhatia is a partner at the firm and Vidushi Maheshwari is an associate.