Taxing Unlisted Shares: Methods and Long Term Capital Gains

When you own unlisted shares, tax considerations might not be the first thing that comes to mind. Since these shares aren’t traded on public exchanges, it might seem like there’s less to be concerned about. However, just like any other asset, unlisted shares are subject to tax implications. 

Understanding how taxes apply to these shares, particularly about Long-Term Capital Gains (LTCG), is important for making informed decisions and managing your financial situation effectively.

In this blog, we’ll explain the taxation of unlisted shares, covering both short-term and long-term capital gains. We’ll walk you through the tax rates for LTCG and STCG, the income tax filing process for unlisted shares, and how to calculate their fair market value. We’ll also discuss what happens when unlisted shares eventually get listed. 

By the end, you'll clearly understand how taxes on unlisted shares’ long term capital gains work in India and why it’s important for your financial planning.

Continue scrolling to learn more!

Why Is Understanding Taxation on Unlisted Shares Crucial?

Understanding the taxation on unlisted shares is crucial for several reasons, especially when managing your capital gains tax in India. Here’s why it matters:

1. Strategic Investment Decisions

Being aware of tax implications can help shape your investment choices. For instance, you may hold unlisted shares longer to benefit from lower tax rates for long-term capital gains. Alternatively, you can plan the timing of sales to minimize taxes and optimize returns, depending on your financial goals and market conditions.

2. Navigating Changes in Tax Law

Tax laws related to unlisted shares can change over time, as we’ve seen with updates to capital gains tax rates. Keeping up with these changes helps you adjust your strategies to take advantage of favourable tax conditions and ensure your decisions remain financially sound.

Now that you see why it's crucial to understand taxes on unlisted shares let's discuss the different types of capital gains you should be aware of.

Types of Capital Gains on Unlisted Shares

When you explore unlisted shares, it’s important to know the different types of capital gains that can arise from these investments. In India, capital gains are classified into two main categories based on how long you hold the shares: Long-Term Capital Gains (LTCG) and Short-Term Capital Gains (STCG).

Here’s a closer look at each type.

1. Long-Term Capital Gains 

LTCG applies when you sell unlisted shares you’ve held for over 24 months. You must hold the shares for at least two years before selling them to qualify for LTCG.

• Tax Rate: In India, LTCG on unlisted shares is taxed at a flat rate of 12.5%. Unlike other investments, LTCG on unlisted shares doesn’t allow for indexation benefits, which would otherwise adjust the purchase price for inflation. Also, LTCG up to Rs. 1,25,000 are not subject to tax. Therefore, the calculation of taxable gain is simple:

  • Taxable Gain = Selling Price - Purchase Price

Benefits:

• Potential for Higher Returns: Holding shares over a longer period can lead to an increase in their value if the company performs well, resulting in higher gains upon selling.

• Tax Planning Advantage: The lower tax rate for LTCG may influence your decision on how long you choose to hold your investments.

2. Short-Term Capital Gains

STCG applies when you sell unlisted shares within 24 months of purchase. If you sell your shares before the two-year holding period, any profit made will be classified as STCG.

• Tax Rate: STCG is generally taxed at 20% for unlisted shares. 

Implications:

• Higher Tax Burden: STCG is taxed at 20%, which can result in a higher tax liability compared to LTCG. This can be significant for those in higher tax brackets.

• Frequent Trading Costs: If you buy and sell unlisted shares frequently, you might incur higher taxes due to STCG, which could reduce your overall returns.

• Investment Strategy Considerations: Knowing that STCG is taxed at a higher rate might encourage you to consider holding your investments longer to avoid frequent trading and the associated tax burden.

With a clear picture of the types of capital gains, let's move on to understanding how to file income tax for your unlisted shares properly.

How to File Income Tax for Unlisted Shares

Filing income tax for unlisted shares involves a few important steps. Here’s a simple guide to help you through the process:

1. Choose the Right ITR Form

You must use ITR-2 or ITR-3 forms if you have unlisted shares. Forms like ITR-1 are not applicable, even if you only have income from salary.

2. Disclose Your Holdings

When filing your return, provide detailed information about your unlisted shares:

• Company Name: Include the name of the company whose shares you own.

• Permanent Account Number (PAN): Mention the company's PAN.

• Details of Transactions: Report the number of shares you bought and sold during the year.

• Opening and Closing Balances: State the opening balance at the start of the year and the closing balance at the end.

3. Report in Part A – General Information

Make sure to declare your unlisted shares in Part A – General Information of your ITR. This section will include all the necessary details about your holdings and transactions.

4. Keep Records

It’s important to maintain records of purchase prices, sale prices, and any other relevant documents. This will help you accurately calculate capital gains and comply with tax regulations.

5. Pay Attention to Tax Payments

Be sure to pay any tax due on LTCG or STCG on time. Timely payment is important to avoid penalties and ensure smooth filing.

After handling the income tax filing for your unlisted shares, the next important task is calculating their fair market value.

Calculating the Fair Market Value of Unlisted Shares

Accurately calculating the Fair Market Value (FMV) of unlisted shares is crucial for tax compliance, especially when determining potential long-term capital gains tax. 

To ensure accuracy and legal compliance, consulting with a qualified professional or a merchant banker is recommended when performing these calculations. The guidelines for calculating FMV are outlined in the Income Tax Rules, 1962, specifically under Rule 11UA. This rule provides a structured approach to determining the FMV, which is important for tax purposes.

Key Formula for FMV Calculation

To calculate the FMV of unquoted equity shares, use the following formula:

FMV = (A + B + C + D - L) × PV × PE

Where:

• A = Book value of all assets (excluding items like jewellery)

• B = Any other relevant assets

• C = Additional assets as prescribed

• D = Further adjustments as necessary

• L = Total liabilities of the company

• PV = Present value factor

• PE = Price to earnings ratio

Steps to Calculate FMV

Here are three steps to follow when calculating the Fair Market Value (FMV) of unlisted shares:

1. Identify Assets and Liabilities: Start by reviewing the company’s financial statements. List all assets and their book values, along with all liabilities.

2. Apply the Formula: Plug in the values for A, B, C, D, and L into the formula to get the preliminary FMV.

3. Consider Adjustments: Depending on the situation or additional company data, you may need to adjust your calculations, such as accounting for goodwill or other intangible assets.

Methods for Valuing Unlisted Shares

Along with the formulaic approach, there are several other methods to value unlisted shares, including:

After determining the fair market value, you might wonder what changes when those unlisted shares become listed on the stock exchange.

What Happens to Unlisted Shares Once They Are Listed

When unlisted shares transition to being listed on a stock exchange, several significant changes can affect both the shares and you as a shareholder. Here's what to expect:

1. Increased Liquidity

Once the shares are listed, they become more liquid. This means you can buy and sell them more easily on the stock exchange than when they were unlisted, where trading was limited to private markets. With more buyers and sellers available, transactions happen more quickly.

2. Price Discovery

Listing your shares on the stock exchange allows for a transparent price discovery process. Market forces will now determine the share price, reflecting the company's performance and investor sentiment. This can result in fluctuations in the share price that were not as noticeable when the shares were unlisted.

3. Regulatory Compliance

Listed companies must follow stricter regulations set by the Securities and Exchange Board of India (SEBI) and stock exchanges. These include regular financial disclosures, corporate governance practices, and compliance with trading regulations, all of which can help build investor confidence.

4. Tax Implications

The tax treatment of gains from listed shares is different from unlisted shares. If you hold the shares for more than a year, LTCG tax will apply. If you sell them within a year of listing, short-term capital gains STCG tax will be applicable.

5. Shareholder Rights

As a shareholder in a listed company, you'll gain certain rights, such as voting at Annual General Meetings (AGMs) and receiving dividends based on the company’s performance. These rights may not have been as clearly defined when the shares were unlisted.

Conclusion

The taxation of unlisted shares’ long-term capital gain depends significantly on the holding period and classification of gains. Understanding these factors is essential for making accurate income tax filings.

By grasping the differences between long-term and short-term capital gains, you can ensure that your tax returns reflect the correct calculations, helping you avoid penalties and optimize your tax situation.

If you're looking to expand your investment opportunities, Precize provides access to private equity investments, allowing you to buy, & sell unlisted shares and pre-IPO shares.

Reserve access to Precize for portfolio diversification and to explore additional investment opportunities!

Disclaimer

The information provided in this blog is for general informational purposes only and should not be construed as legal, financial, or tax advice. Tax laws and regulations are subject to change, and individual circumstances may vary. It is recommended to consult with a qualified tax professional or financial advisor for specific guidance regarding the taxation of unlisted shares, long-term capital gains, and other related matters.