GST Implications on Initial Public Offerings (IPOs) and Offers for Sale (OFS) in India
The introduction of the Goods and Services Tax (GST) in India in July 2017 marked a monumental shift in the country's indirect tax regime, aiming for a unified and simplified taxation system. While the primary objective was to streamline the taxation of goods and services, its application to the capital markets, particularly Initial Public Offerings (IPOs) and Offers for Sale (OFS), has given rise to intricate interpretations and compliance challenges. Companies contemplating a public listing, existing shareholders seeking to divest their holdings, and the array of financial intermediaries involved must navigate these implications meticulously to ensure tax efficiency and avoid potential disputes.
Understanding IPOs and OFS in the GST Framework
An Initial Public Offering (IPO) signifies a company's inaugural sale of shares to the general public to raise fresh capital. The proceeds from an IPO directly augment the company's coffers, which are then deployed for strategic initiatives such as business expansion, debt reduction, or other corporate objectives.
Conversely, an Offer for Sale (OFS) involves existing shareholders, typically promoters or private equity investors, offloading a portion of their pre-existing shares to the public. In an OFS, the sale proceeds accrue directly to the selling shareholders, rather than to the company itself.
The core GST dilemma for both IPOs and OFS revolves around the classification of shares as "goods" or "services" under the GST legislation.
Shares and Securities: Outside the GST Ambit
The Central Goods and Services Tax (CGST) Act, 2017, explicitly carves out "securities" from the definitions of both "goods" and "services." This exclusion is fundamental: it means that the direct issuance or transfer of shares, in and of itself, does not attract GST on the value of the shares transacted. Consequently, the act of a company issuing shares in an IPO or existing shareholders selling shares in an OFS is not subject to GST on the transaction value of those shares.
However, the exemption for securities does not extend to the array of services integral to the execution of an IPO or OFS. These related services fall within the purview of GST, typically attracting an 18% levy, and this is where the complexities, particularly concerning Input Tax Credit (ITC) eligibility, emerge.
GST on Ancillary Services for IPOs and OFS
Bringing a company to the public market is a multifaceted process that necessitates the engagement of numerous service providers. The fees charged for these distinct services are subject to GST. Key services attracting GST include:
Merchant Banking Fees: Merchant bankers are pivotal in orchestrating the entire IPO/OFS process, encompassing due diligence, regulatory compliance, pricing, and marketing. Their professional fees are subject to GST.
Underwriting Fees: Underwriters assume the risk of under subscription by committing to purchase any unsold shares. The fees they charge for this assurance are subject to GST.
Brokerage and Commission: Stockbrokers facilitate the buying and selling of shares for investors. The brokerage and commission they earn are subject to 18% GST.
Legal and Professional Fees: Companies engage legal counsel, auditors, and other specialists for drafting the prospectus, ensuring adherence to SEBI regulations, and conducting comprehensive due diligence. Their professional fees attract GST.
Registrar and Transfer Agent (RTA) Fees: RTAs manage the share registry, process applications, allocate shares, and handle refunds. Their services are subject to GST.
Listing Fees: Fees paid to stock exchanges (such as BSE and NSE) for listing the company's shares are subject to GST.
SEBI Fees: The Securities and Exchange Board of India (SEBI) imposes various charges for its regulatory oversight. While SEBI charges were initially exempt, an 18% GST has been applicable on them since July 18, 2022.
Advertising and Marketing Expenses: Companies incur substantial costs for advertising the IPO and undertaking marketing campaigns to attract investor interest. GST is applicable to these services.
Depository Participant (DP) Charges: These charges are levied when shares are debited from a Demat account upon sale and are subject to GST.
Annual Maintenance Charges (AMC) for Demat Accounts: Fees for maintaining Demat accounts are also subject to GST.
Input Tax Credit (ITC) Availability: A Contentious Landscape
The availability of Input Tax Credit (ITC) on GST paid for IPO/OFS-related services is perhaps the most debated aspect. Companies accrue significant GST expenses, leading to the crucial question of whether they can claim ITC on these expenditures.
Divergent Views: Tax Authorities vs. Industry:
Tax authorities often contend that since the fundamental output of an IPO/OFS (i.e., the issuance or sale of shares) is an "exempt supply" (given that securities are neither goods nor services), the ITC on associated input services should be disallowed. This stance typically relies on Section 17(2) of the CGST Act, which restricts ITC to the extent that goods or services are used for making exempt supplies. Furthermore, Section 17(3) explicitly includes "transactions in securities" within the ambit of exempt supplies for the purpose of ITC reversal. Rule 42 of the CGST Rules then outlines the mechanism for proportionate ITC reversal for common credits used for both taxable and exempt supplies.
Conversely, the industry strongly argues that expenses incurred for an IPO, particularly for a fresh issue, are intrinsically linked to raising capital. This capital is subsequently deployed for the furtherance of the company's taxable business operations. Therefore, these expenses should be considered "input services" utilized in the course or furtherance of business, making the ITC eligible under Section 16(1) of the CGST Act.
Pre-GST Regime and Judicial Precedents:
Before the advent of GST, under the CENVAT credit regime, tax authorities frequently disallowed credit on IPO-related expenses. However, appellate tribunals and courts often ruled in favor of assessees, asserting that the funds raised through public issues were integral to the company's overall business activities, which inherently included taxable outputs. These historical precedents serve as a robust foundation for advocating for ITC availability under the current GST framework.
Nuances in ITC Eligibility based on Issue Type:
Fresh Issue (IPO): For a fresh issue, where the capital directly flows into the company and is earmarked for its taxable business operations, there is a strong and justifiable argument for ITC eligibility. The funds are undeniably connected to the company's future taxable supplies.
Offer for Sale (OFS): In an OFS, the proceeds directly benefit the selling shareholders, not the company. Consequently, the argument for ITC availability for the company on expenses exclusively related to an OFS is significantly weaker. If the expenses are borne by the selling shareholders, the question of ITC for the company does not arise. Services procured by the company solely to facilitate an OFS, and not for its own business purposes, are unlikely to be eligible for ITC.
Combination of Fresh Issue and OFS: In scenarios involving both a fresh issue and an OFS, the ITC would likely be allowed proportionally to the extent of the fresh issue portion, with restrictions applied to the OFS component.
The "1% of Sale Value of Securities" Rule (Rule 42/43):
Rule 42 of the CGST Rules provides a formula for the reversal of common ITC attributable to exempt supplies. Explanation 2(b) to Rule 45 further stipulates that for determining the value of an exempt supply under Section 17(3), the value of security shall be taken as 1% of its sale value. If the tax authorities' interpretation - that the issuance of shares constitutes an exempt supply for ITC reversal purposes - is upheld, companies could face substantial ITC reversals calculated as 1% of the total issue size. This interpretation remains highly contentious, with many arguing that the "issue" of shares in an IPO is fundamentally different from a "sale" of shares in the secondary market, and therefore, the 1% rule for ITC reversal should not automatically apply to a fresh issue of shares.
Other Pertinent Considerations
ESOPs (Employee Stock Option Plans): The GST implications of shares issued to employees under ESOPs also present a complex area. The debate centers on whether such issuance, being a form of consideration for services rendered, constitutes a taxable supply. Generally, since securities are excluded from the definitions of goods and services, the direct issuance of ESOPs themselves is not subject to GST. However, valuation aspects and any indirect GST implications warrant careful analysis.
Foreign Investment: For foreign investors participating in IPOs or OFS, the GST implications on various fees generally remain consistent. However, the specific mechanisms for payment and ITC claims (if applicable) would depend on the prevailing cross-border transaction rules.
Impact on Fundraising Costs: The potential disallowance of ITC on significant IPO/OFS expenses can substantially inflate the effective cost of fundraising for companies. This directly impacts their financial viability and the overall attractiveness of seeking public listings in India.
Conclusion
The GST regime has undeniably introduced layers of complexity to the landscape of IPOs and OFS in India. While the core transaction of issuing or transferring shares is outside the direct GST levy, the myriad of ancillary services supporting these capital market activities are subject to GST, fueling ongoing debates regarding ITC eligibility.
The persistent stance of tax authorities in often denying ITC on IPO expenses, by classifying the issuance of shares as an "exempt supply," continues to be a major point of contention. Companies and their advisors frequently invoke pre-GST judicial precedents and the fundamental principle that capital raised serves the furtherance of taxable business activities. A definitive clarification from the GST Council or a conclusive judicial pronouncement on this specific matter is eagerly awaited to bring much-needed certainty and reduce litigation.
For any company considering an IPO or OFS, a comprehensive and meticulous assessment of all potential GST liabilities and ITC implications is imperative. Engaging seasoned tax professionals is crucial to navigate these intricate provisions, structure transactions optimally, and proactively mitigate any risks associated with GST compliance and potential disputes. Given the dynamic nature of GST interpretations, a forward-looking and proactive approach is essential to ensure that fundraising endeavors are not only successful but also tax-efficient.
Disclaimer: The information given in this article is solely for purpose of understanding the law. It is completely based on the interpretation of the author and cannot be constituted as a legal advise, the author of this article and Lawcrux team is not responsible for any legal issues if arises on the basis of the interpretation given above.