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Bonus or dividend, don't forget tax in the end
November, 30th 2007
You read a newspaper and come across an announcement of bonus shares, or you realise that a company in which you are a shareholder has decided to demerge. what would be its tax implications? Read further.

Dividend: Any dividend, interim or final, that you receive from an Indian company is not taxable in your hands. However, the Indian company paying such dividends has to cough up dividend distribution tax.

The same is not true when it comes to dividends from shares in foreign companies these will be taxable in your hands based on the slab of income in which you fall. As is widely known, individuals can invest up to $200,000 per year whether for acquiring immovable property overseas or foreign shares/securities or units of overseas mutual funds.

Thus, if you have received dividends from a foreign company, you will get taxed in India. If tax has been withheld in the foreign country, you could claim a credit for the same in your tax return.

Bonus, rights issue, buyback and stock split: In a bonus issue, you are awarded additional shares, in the ratio determined by the company. For instance, in a 1:1 ratio, you get a bonus share for every share held by you. While your shareholding will increase with the issue of bonus shares, it is important to not make the mistake of spreading out cost of your original shares, as whenever the bonus shares are sold, the cost of such shares will be considered to be nil.

For example, Ryan holds 100 shares of company A which were purchased (cost of acquisition) for Rs 2 lakh. Post declaration of bonus, Ryan was allotted 100 additional shares by the company.

The cost of the bonus shares will be considered to be nil and not Rs 1 lakh when determining the capital gains on sale of these bonus shares. Capital gains is the difference between the sale consideration and the cost of acquisition.

In a rights issue, the company entitles its shareholders to subscribe for additional shares. Where the shareholder renounces the right to subscribe to the right shares to a third party, the entire amount received for the renouncement will be taxable as capital gains. Where the rights shares are subscribed to and are subsequently sold, the amount actually paid for acquiring such shares will be considered as cost for determining the capital gains.

For determining whether the capital gains in case of bonus or right shares is short-term/long-term in nature, the date that one should consider is the date of actual receipt of such shares and not the date when the original shares were acquired.

If shares are held for more than 12 months, then the capital gains arising on sale are long-term capital gains. Long-term capital gains (LTCGs) are tax exempt if the transaction is done on a recognised stock exchange and Securities Transaction Tax (STT) has been paid upon the sale. Thus, it is essential to ascertain the correct period of holding.

A company may offer to buy back the shares held by shareholders. In such cases of buyback, the capital gains is the excess of buyback price over the original cost of shares. Stock split has no tax implications. Here, the face value of the share is split the end result is that you end up holding a larger number of shares. You only need to apportion the original cost over the number of shares post the stock split.

Amalgamation and Demerger: While both are important events for the company, for the shareholders it means receiving shares of a new company in lieu of shares originally held (in case of amalgamation) and receiving shares of one or more companies as a result of shares originally held (in case of demerger).

In the case of amalgamation, the receipt of new shares in lieu of old shares is not treated as transfer of shares and hence not liable for capital gains. When the new shares received are sold, cost of the original shares will be considered for determining the capital gains.

In a demerger, due to the hive-off of one or more businesses of the company into a separate company, shares are issued by the new company to the shareholders. As a business is carved out from the original company, the cost of original shares is bifurcated in a ratio which is provided to the shareholders on issue of new shares.

The shareholders need to apply the ratio to determine the cost of new shares issued as a result of demerger and to reduce the cost of shares originally held. For example, Beena acquired 100 shares in company X on August 1, 2000 for Rs 12,000. Pursuant to demerger of the company, Beena received further 20 shares in company Y on January 1, 2007.

The ratio provided to the shareholders on demerger was 67:33. Accordingly, the cost of 100 shares in company X will be Rs 8,000 and of 20 shares in company Y will be Rs 4,000.

In both the cases, when the new shares received are sold, the period of holding of both the original shares and the new shares is to be considered to ascertain whether the capital gains is short-term/long-term in nature. For example, Beena sold the shares of company Y on April 1, 2007. Capital gains thereon will be long-term in spite of Beena holding shares for less than one year.

Chetan Mehta
Ernst & Young
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