Tax Implications for Shareholders in HDFC–HDFC Bank Merger

HDFC BANK – HDFC Ltd merger

With the HDFC Bank merger with HDFC Ltd completed and the expanded capital of HDFC Bank already listed, it is instructive to quickly look back if this deal has any tax implications. After all, if you are an HDFC Bank shareholder, then nothing much may happen to your holdings. However, if you were a shareholder in HDFC Ltd, then your shares would have been swapped for shares of HDFC Bank and the same would have been credited to your demat account. The record date for the merger was July 13, 2023, and HDFC Ltd shareholders would have already been issued shares of HDFC Bank in lieu of shares of HDFC Ltd held. The swap ratio had been fixed at 42:25 That means shareholders of HDFC Ltd will get 42 shares of HDFC Bank for every 25 shares of HDFC Ltd held by them. We now raise two questions. Will the shareholder of HDFC Ltd pay tax for the swap? Secondly, what will be the tax implications when the shares of HDFC Ltd swapped into HDFC Bank are sold?

Will shareholders pay tax on HDFC Ltd shares swapped?

For the purpose of income tax, the listed shares of HDFC Ltd and HDFC Bank are considered as capital assets and the rule of listed shares will apply to them. That means; if the shares are held for up to 12 months, then it will be short term capital gains (STCG) and if held for more than 12 months it will be long term capital gains (LTCG). However, such capital gains tax would be applicable only on sale. The mere allotment of shares of another company under an NCLT-approved scheme of arrangement will not tantamount to capital gains. Hence no capital gains will be applicable on shareholders merely for the swapping of the shares of HDFC Ltd into shares of HDFC Bank. 

Under the Income Tax Act, the swap of shares is not considered as a transfer of shares, making it tax neutral for shareholders. However, this is only true when 2 conditions are satisfied. Firstly, all assets and liabilities of the amalgamating company must be transferred to the amalgamated company. Secondly, at least 75% of shareholders by value must become shareholders of the amalgamated company. In the case of HDFC Bank merger, both these conditions are satisfied, so merely the swap would not result in any capital gains in the hands of the investor.

How will sale of swapped shares of HDFC Ltd be taxed?

Now comes the more crucial question. Suppose you were a shareholder of HDFC Ltd and later got shares swapped into HDFC Bank. Now if you sell the shares of HDFC Bank, how will the capital gains be calculated. In short, what would be considered as the cost of acquisition and what would be treated as the date purchase? Would the date or purchase be the swap date or the date you bought HDFC Ltd? 

The answer to both these questions is that the date and price of purchase of HDFC Ltd in the original form would be considered as the base price for the calculation of capital gains. The swap ratio date is not relevant here. However, the original purchase of HDFC Ltd will be adjusted by the swap ratio to make the cost of purchase comparable to the market price of HDFC Bank Ltd. In short, the price and the holding period is counted from the date of purchase of the amalgamating company shares (HDFC Ltd in this case).

How will capital gains calculation work in practice?

The situation may look slightly complex, so the best way is to look at a practical example to understand this better. Here, let us assume that on April 01, 2020, you bought 60 shares of HDFC Ltd on the NSE at a price of Rs1,800. Hence. Your total investment to buy these shares of HDFC Ltd would have been Rs108,000. Now, the swap ratio for the record date of July 13, 2023 was 42:25 in favour of HDFC Ltd. Hence, based on the swap ratio, the investors will get allotted 100.80 share of HDFC bank Ltd on the record date of the merger. Obviously, it is not possible to allocate fractional 0.8 shares so only 100 shares of HDFC Bank will be allotted. The value of the fractional 0.8 shares will be paid to you in cash.

Now for the 100 shares of HDFC Bank that the investor has got via conversion of HDFC Ltd, the effective date of purchase for calculation of capital gains would still be April 01, 2020. But, what about the purchase price? You paid Rs108,000 to buy HDFC Ltd shares and got 100.8 shares. So, the cost of these 100 shares now will be {(108,000 x (100/100.8)}. In other works, the purchase price of these 100 shares would be Rs107,142.86 or you can say that the cost price based on swap ratio of HDFC Bank will be Rs1,071.43 per share.

Let us now assume that post the merger, the 100 shares of HDFC Bank are sold at Rs1,680. Hence, the capital gains per share in this case will be Rs608.57 (1,680.00 – 1071.43). In other words, the capital gains of the swapped shares are Rs608.57 per share or you can even say Rs60,857 for 100 shares. As shares were purchased in April 2020, this will be long term capital gains taxed at a flat rate of 10% over Rs1 lakh. If you don’t have any other capital gains in the year, then these capital gains will be tax free as they are below Rs1 lakh. Anything in excess of Rs1 lakh will be charged LTCG tax at a flat rate of 10%. In addition, the consideration received for the fractional share will be taxed as income in your hands.

Finally, let us also make a point here on grandfathering of LTCG. What if you had bought the shares of HDFC Ltd before January 31, 2018 when the exemption on LTCG was removed. In that case the grandfathering clause will apply and you will only be taxed on capital gains arising on or after January 31, 2018; not before that. In the HDFC Bank / HDFC Ltd merger deal, the capital gains will only arise when such swapped shares are sold, not otherwise.