IPO expenses - Whether GST credit available?

 

Darshan Savla, CA, CS, LLB

 

Background

 

Indian stock exchanges have achieved global prominence in terms of the number of initial public offerings (IPOs) in 2023. According to annual reports by the Securities Exchange Board of India (SEBI), companies have raised approximately INR 5.15 lakh crores through public and rights issues in the past five years, from April 2017 to March 2023.

 

IPOs serve as a means for companies to secure capital from the general public, simultaneously attracting investors with the promise of early-stage entry and potential for higher returns.

 

However, conducting an IPO comes at a cost for companies. During public and rights issue, companies incur various issue-related expenses such as merchant banker fees, underwriting commission, legal fees, printing and advertisement expenses and listing fees payable to the stock exchanges, amongst others.

 

In case of an IPO, the quantum of such expenses could range from 3-10% of the funds raised and in case of smaller companies, the said expenses could even go above 10%.

 

Types of public and rights Issue:

 

There are several methods for resource mobilization in the primary market:

 

o   Initial Public offer: An initial public offering (IPO) refers to the process of offering shares of a private company to the public at large by listing its shares on stock exchange for the first time.

 

o   Offer for sale: An Offer for Sale (OFS) is a simpler method wherein shareholders / promoters in public companies can sell their shares and reduce their holdings in a transparent manner through stock exchange.

 

o   Follow-on public offer: Follow-on Public Offer ('FPO') is a process in which an existing company listed on stock exchange issues new shares to the existing shareholders or to the new investors.

 

o   Rights Issue: A rights share issue is an offering of rights given to a company's existing shareholders, allowing them to purchase additional shares directly from the company at a discounted price, rather than buying them through the secondary market. The number of additional shares that a shareholder can purchase depends on their existing holding.

 

Dispute from GST Authorities

 

Recently, the tax authorities have been issuing notices to companies, demanding reversal of input tax credit (ITC) availed of GST paid on such issue-related expenses. The view adopted by the tax authorities is that the public and rights issue of shares, being 'transaction in securities', is not subject to GST law. Consequently, they contend that ITC of GST paid on such expenses shall not be eligible for availment as per GST law.

 

Provisions under GST law

 

Section 16(1) of the Central Goods and Services Tax Act, 2017 ('CGST Act') allows registered persons to claim credit for input tax charged on supplies used or intended for use in their business, subject to prescribed conditions.

 

Section 17(2) of the CGST Act states that if goods or services are used partly for taxable supplies including zero rated supplies and partly for exempt supplies, the credit will be restricted to the portion attributable to taxable supplies.

 

Section 17(3) of the CGST Act provides that the value of exempt supply under sub-section (2) shall include supplies on which the recipient is liable to pay tax on reverse charge basis, transactions in securities, sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building.

 

The manner of computation of eligible ITC has been provided in Rule 42 & Rule 43 of the Central Goods and Services Tax Rules, 2017 ('CGST Rules')

 

Explanation 2(b) to Rule 45 of the CGST Rules provides that the value of security shall be taken as 1% of the sale value of such security for determining the value of an exempt supply as referred to in sub-section (3) of section 17.

 

Issue involved:

 

Shares are classified as 'securities' and are expressly excluded from the definition of goods and services under GST law. Consequently, in principle, transactions involving securities fall outside the purview of GST law.

 

Section 17(2) of the CGST Act stipulates that ITC shall not be available for expenses related to 'exempt supplies.' As per sub-section (3), the value of 'exempt supplies' for the purpose of sub-section (2) shall include 'transaction in securities'.

 

The term 'transaction' is sufficiently broad to encompass all aspects related to shares. It is conceivable that even the 'issuance' of shares by a company might fall under the scope of 'transaction in securities' as defined in Section 17(3) of the CGST Act, necessitating its inclusion in the value of exempt supplies for the purpose of calculation of ITC reversals under Section 17(2) of CGST Act.

 

However, on the other hand, explanation 2 to Rule 45 of CGST Rules stipulates that the value of security shall be taken as 1% of the sale value of such security for the purpose of Sec. 17(2) of CGST Act. 

 

Accordingly, it is unclear whether 'issue' of shares by the company can be equated with 'sale' of shares and consequently, the value of capital raised through issue of shares may be required to be considered as part of the value of 'exempt supplies' when calculating ITC reversals under Section 17(2) of the CGST Act.

 

Pre-GST position:

 

Even before GST, tax authorities denied CENVAT credit on expenses related to IPOs. However, the Appellate Authorities allowed such credit, considering these expenses as directly or indirectly related to a company's business.

 

FAQ by Institute of Chartered Accountants of India (ICAI):

 

In its 'Practical FAQs under GST' released on 04 December 2022, ICAI clarified that ITC is admissible for IPO expenses.

 

International position:

 

Similar provisions existed in Austrian VAT law. In case of Kretztechnik C-465/03 [26 May 2005], the tax authorities did not allow deduction of the input VAT paid by Kretztechnik (taxpayer) on the supplies linked with its admission to the stock exchange since the issuing of shares is regarded in Austria as being exempt from VAT.

 

In the above case, the Court of Justice observed that share issue does not constitute a supply of goods or of services for consideration.

 

Further, it was observed that the issue of shares was carried out by Kretztechnik in order to increase its capital for the benefit of its economic activity in general and that the costs incurred by the company in connection with such issue of shares formed part of its overheads and as such, included in the price of products sold by the company. Those expenses have a direct and immediate link with the whole economic activity of the taxable person.

 

Accordingly, the Court allowed deduction of VAT charged on the expenses incurred by a taxable person in connection with issue of shares, provided that all the transactions undertaken by the taxable person in the context of his economic activity constitute taxed transactions.

 

Comments:

 

IPO, FPO and rights issue:

 

A company that issues new shares is increasing its assets by acquiring additional capital, whilst granting the new shareholders a right of ownership of part of the capital thus increased. From the issuing company's point of view, the aim is to raise capital and not to trade in securities. As far as the shareholder is concerned, payment of the sums necessary for the increase of capital is not a payment of consideration but an investment or an employment of capital. Further, the capital raised by the company will be used in the course or furtherance of business.

 

Accordingly, a view may be taken that the 'issue' of shares through IPO, FPO or rights issue could not be equated with 'sale' of shares and therefore, the value of capital raised through such issue of shares shall not be included in the value of 'exempt supplies' for the purpose of calculation of ITC reversals u/s 17(2) of CGST Act. However, the eligibility of ITC will be subject to fulfilment of other prescribed conditions under GST law.

 

Offer for sale:

 

In case of OFS, the promoters reduce their stake by offering their shares for sale. The Company issues the prospectus related to OFS and incurs expenses, which are later reimbursed from the promoters. The sale proceeds of the shares are received by promoters.

 

Accordingly, in case of OFS, the GST implications may differ as the same may be considered as 'sale' of shares by promoters and required to be included in the value of exempt supplies by promoters for the purpose of calculation of ITC reversals under section 17(2) of the CGST Act.

 

Further, in case promoters and company are considered as related persons under GST law, the GST implications on any services supplied by company to promoters may have to be evaluated since the same may be considered as 'deemed supply' even in absence of any consideration.

 

Conclusion:

 

Industry players should assess GST credit eligibility for expenses related to various types of issues including QIPs, IPPs, INVITs, IDRs, ESOPs, etc., as the GST implications may vary depending on the facts.

 

Given the substantial size of public and rights issues, estimated GST credits availed by companies on such issue-related expenses may range from INR 2,500 to 7,900 crores since the inception of GST in 2017.

 

With the increasing trend of raising funds through IPOs and FPOs in India, the GST credits claimed by companies will continue to grow. In light of this significant GST exposure, the Government should act promptly and provide the necessary clarification to resolve the ambiguity.

 

[Date: 04/09/2023]

 

(The views expressed in this article are strictly personal.)