Offer for sale in an IPO

An offer for sale lets existing shareholders, often promoters or early investors, sell their own shares to the public, instead of the company issuing new ones. When those shares being sold were unlisted before the IPO, tax law has to decide which set of rules applies: the harsher unlisted-share rules, or the more generous listed-share rules.

The workbook's answer is specific: gains on unlisted equity shares sold via an offer for sale within an IPO are taxed under Section 112A, the same section that governs ordinary listed, STT-paid equity shares.

The general rule for unlisted shares (section 11.3). Unlisted shares are a short-term capital asset if held for not more than 24 months; beyond that, long-term. Long-term gains on unlisted shares are normally taxed at 12.5% plus surcharge and cess, without the section 112A exemption or STT requirement that apply to listed shares.

The carve-out for an IPO offer for sale. Where unlisted equity shares are offered for sale under an IPO, the resulting gain is instead taxed in accordance with Section 112A, meaning it is treated as if the shares had gone through the STT-paid, listed-equity route: exempt up to Rs 1,25,000 a year, 12.5% above that.

Why the distinction exists. The moment of the IPO is also, typically, the moment the shares become listed and the sale itself attracts STT. The rule effectively recognises that a share sold to the public through an IPO is functionally the same event as selling a newly listed, STT-paid share, even though, technically, the seller's shares were unlisted right up until the offer for sale within the IPO.

A promoter, Mr Bansal, has held unlisted shares of his company for 6 years, at a cost of Rs 2,00,00,000. The company goes public through an IPO that includes an offer for sale of Rs 5,00,00,000 of his shares, priced at the IPO issue price, with STT paid on the transaction.

Because these shares are sold to the public through the IPO's offer for sale, the gain is taxed under Section 112A, not under the ordinary unlisted-share rule:

Sale consideration (offer for sale)      Rs 5,00,00,000
Less: cost of acquisition                Rs 2,00,00,000
Long-term capital gain                   Rs 3,00,00,000
Less: section 112A exemption             Rs     1,25,000
Taxable long-term gain                   Rs 2,98,75,000
Tax at 12.5%                             Rs   37,34,375

Had Mr Bansal instead sold the same unlisted shares in a private transaction just before the IPO, outside the offer-for-sale route, the ordinary unlisted-share rule would apply instead: 12.5% on the full Rs 3,00,00,000 gain, with no Rs 1,25,000 exemption, since section 112A's benefit is specifically tied to the STT-paid, IPO offer-for-sale route.

Chapter 11 (Taxation of Equity Products), section 11.3.2 (Tax on long-term capital gains from unlisted shares), states the offer-for-sale-in-an-IPO carve-out directly, immediately after the general unlisted-share long-term rate. Expect a question testing whether a described sale of unlisted shares qualifies for section 112A treatment. The answer turns entirely on whether the sale happened through an IPO's offer for sale.

• The carve-out applies only to the offer-for-sale route within an IPO. An ordinary private sale of the same unlisted shares does not get section 112A treatment.
• Section 112A brings both the Rs 1,25,000 exemption and the 12.5% rate. An unlisted-share sale outside this carve-out gets 12.5% but no exemption.
• This is a different concept from the general offer-for-sale mechanism, which covers who gets the sale proceeds and applies across follow-on offers and placements too. This entry is specifically about how the resulting capital gain is taxed when the shares sold were unlisted.
• STT is what usually accompanies an IPO offer for sale in practice, but the rule as stated in the workbook attaches to the offer-for-sale-in-an-IPO route itself, not to a separate STT test layered on top.