Conversion of compulsory convertible preference shares into equity shares is not “transfer”

In the case of Periar Trading Company Private Limited (Taxpayer), the issue before the Mumbai Income Tax Appellate Tribunal (Tribunal)  was whether conversion of compulsory convertible preference shares (CCPS) into equity shares can be treated as “transfer” as per India Tax Laws (ITL) and whether the difference between the cost of acquisition of CCPS and market value of equity shares on the date of conversion attract capital gains taxation as per the ITL. The dispute involved in this case pertains to tax year prior to insertion of specific provision in the ITL which exempts such a conversion.

The Tribunal held that conversion of CCPS into equity shares cannot be regarded as an exchange, barter or swapping of one form of shares for other form. Rather, it is a case where the original shares (CCPS) ceased to exist upon its conversion into other form of shares (equity), not constituting a “transfer” and, hence, does not attract capital gains. The Tribunal placed reliance on a CBDT Circular clarifying that conversion of one type of share into another type of shares does not constitute “transfer” as also on a provision in the ITL in terms of which in the event of conversion of one type of shares into another, the cost of acquisition of erstwhile shares is deemed to be cost of acquisition of converted shares. The Tribunal further held that, adopting this view does not result in leakage of income, on the contrary taxing capital gain upon conversion would not only be against the legislative intention but also lead to double taxation.

Article referred: https://www.ey.com/Publication/vwLUAssets/converaion_of_ccps/%24FILE/converaion_of_ccps.pdf