Companies planning open offers or share buyback could face a problem, with Finance Minister P Chidambaram's proposal to exempt long-term capital gains on stock exchange transactions from income tax.

As open offers, where shares are tendered directly and not on a stock exchange, will continue to attract long term capital gains, it becomes more beneficial for shareholders to sell their stock on an exchange rather than subscribe to an open offer and pay income tax on long term capital gains.

A similar issue faces buybacks from companies. As subscription to a buyback offer is not carried out on a stock exchange, here again shareholders run the danger of paying income tax on their long term capital gains.

"This puts M&A in an adverse position," said Rajeev Memani, CEO and country managing partner, Ernst & Young India. "Eventually, these transactions (open offer and share buyback) too will have to be brought under the exemption," Jindal Stainless director (finance) Arvind Parakh added.

"This needs an urgent amendment in the Finance Bill, failing which it would be an anomalous situation that would work  against takeover activity in the capital market," said Somasekhar Sundaresan, a partner in the law firm J. Sagar Associates.

Several CFOs Business Standard spoke to said they expected the government to rectify the problem shortly. "I am absolutely confident that it will be sorted out," Indo Rama Synthetics (I) director Shailendra Tandon said.

The Budget had sought to amend the Income Tax Act to exempt long term capital gains made on the stock exchange from income tax.

This means, shareholders need to pay a capital gains tax on any transaction not carried out on the floor of a stock exchange, depending on how long they have held the stock.

In the case of an open offer, the merchant banker of the acquirer opens a counter where the shares are deposited directly. It does not form a part of a stock exchange's turnover.

Spanner in the works Exempt from long term capital gains tax All securities transactions on the stock exchange. Not exempt from long term capital gains: Open offer Share buyback Negotiated deals