Sunday, 14 July 2013

Taxation of Bonus Shares

Section 45- charging section for capital gains:
Section 45 is charging section. Various sub-sections of this section provide for charging of any profit or gains and in some specified exceptions even ‘capital value’ is also deemed to be capital gain taxable under the head.
There are different provisions for computation of capital gains in case of short-term capital assets, long-term capital assets, depreciable assets, slump sale, and for additional compensation when original compensation was assessed, etc.

Charging section and computation provisions are integral code:
It is now well settled that charging section and provisions for computation of taxable matter and / or amount of tax are integral code and in case a computation cannot be made as per prescribed provisions for computation, then the charging section shall also not apply.
Charging section 45(1):
Sub-section (1) of section 45 is broader and general charging section. Other sub-sections of section 45 are case specific provision for computation and charge of specified gain or receipt. In some sub-sections even capital value, is considered as capital gains however that is due to some specific reasons applicable in particular situation. In this write-up we are concerned with cases falling under sub-section (1).
Capital assets having no cost of acquisition:
In case a capital asset is one which was acquired without incurring any cost of acquisition, then sale value of such assets minus nil is sale value or capital value of assets. In such cases it cannot be said that the sale value is profit or gain. The concept of profit or gain is based on sale value or consideration minus total cost incurred.
Judgments in case of CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Gujrat) and K. N. Daftary v. CIT [1977] 106 ITR 998 (Cal) taking view that entire sale value can be considered as capital gains, were disapproved by the Supreme Court in B.C.Sriniwas Setty’s 128 ITR 294 (SC) and the Supreme court held that sale value minus nil remain capital value and there is no element of profit or gain chargeable u/s 45.
Deemed nil cost:
Under section 55 in relation to some capital assets for which in fact there is no cost of acquisition, it is prescribed that the cost of acquisition is nil. Similarly for some assets it is provided that cost of improvement is nil.
As per author these provisions, recognizes that specified assets have no cost of acquisition or no cost of improvement. The implications of these provisions can only be restricted to such ground reality for ascertaining cost instead of leaving taxpayer and tax authorities to work out cost in different manner or tax payer claiming that cost is nil and tax authorities determining some cost in one or other manner.
As per author, the legal position as to chargeability of taxable capital gains has not undergone any change by the prescription of cost as nil. Gains, if any is taxable u/s 45(1) as ‘profit’ or ‘gain’. Sale value minus nil still remain to be capital value and there is no element of profit or gain in it. Where any other sub-section of section 45 or other provision is not applicable as charging provision, sale value cannot be charged under section 45(1).
Indexation of cost of acquisition and cost of improvement:
There is significant difference in statutory provisions about computation of taxable capital gains in case of short term capital assets and long term capital assets. Transfer of a long term capital asset cannot be equated to transfer of a short term capital assets. In fact transfer of an asset held for say three years and another asset held for four years are treated differently. Same and similar asset (say shares acquired at same price) held for three years and four years will receive different treatment. This is because cost inflation index of year of acquisition are different.
Increasing allowable cost by application of cost inflation index is a major feature of computation provision. The scheme of computation is such that with passing of years, allowable costs are increased and element of taxable capital gain is reduced. This is intended to tax actual capital gains by inflating allowable costs of long –term capital assets. Though only 75% of inflation is taken into account while prescribing cost inflation index, however, this is a fiscal decision. But fact remains that with passing of time taxable capital gains are reduced because allowable cost of acquisition is increased to compensate for inflation. This is reason that when a client decide to sell a capital asset during last part of the previous year, we suggest him to defer the transfer to the month of April, so that higher cost inflation index can be applied and higher inflated cost can be claimed to reduce taxable capital gains, besides other better options and extra time for reinvestment can be availed.
Cot nil cannot be inflated:
The amount of cost of acquisition or cost of improvement cannot be inflated if such cost is factually nil or deemed to be nil. Suppose a shareholder has received bonus shares, in relation to 100 original shares having cost of Rs. 10000 acquired on 01.01.2005, as follows:
Bonus in ratio of 1:1 on 100 allotted on 01.04.05 100 total holding 200
Bonus in ratio of 1:1 on 200 allotted on 01.04.07 200 total holding 400
Bonus in ratio of 1:1 on 400 allotted on 01.04.09 400 total holding 800
Bonus in ratio of 1:2 on 400 allotted on 01.04.10 400 total holding 1200
Bonus in ratio of 1:1 on 1200 allotted on 01.04.12 1200 total holding 2400
Bonus in ratio of 1:1 on 2400 allotted on 01.01.13 2400 total holding 4800
Suppose the shareholder sells entire shares on 25.03.13 @ 150 per share.
For computing capital gains of original shares his cost of Rs.10000/- incurred on 01.01.2005 will be inflated as 10000 / 480 X 852 =17750/- which will be allowed against sale price of Rs.15000/- and he will be allowed long-term capital loss of Rs.2750/-
For 4700 bonus shares he realize @ Rs.150/- per share total Rs.705000/-
Shares allotted on 01.04.12 and 01.01.13 are short term of capital assets as on the day of transfer that is 25.03.13 therefore cost inflation index is not applicable.
For bonus shares allotted earlier, the holding period is more than 12 months and those shares are long term capital asset having different number of years held. Therefore, as per computation provisions the cost need to be inflated with applicable cost inflation index for the year of allotment and year of transfer.
The cost of acquisition is factually nil because shareholder did not pay any cost to acquire bonus shares. Such cost is also deemed to be nil vide section 55. If we take cost as nil, then in case of all bonus shares cost inflation index cannot be applied and different CII cost cannot be computed, because zero or nil will always remain nil irrespective of any multiplier.
Thus the sale value minus zero will remain sale value and there will be no change in the remaining amount due to change of period of holding. The provision for computing long-term capital gain for long term capital asset cannot be applied. Therefore, computation provision fails.
Even for short term bonus shares, sale value minus zero is sale value and there is no element of profit or gain.
The sale value of each bonus share also remain to be sale value or capital value, and there is no element of profit or gain which can be taxed u/s 45 (1). Any other charging provision is also not applicable. Therefore, sale value of bonus shares is not taxable as ‘capital gains’.
Decided cases after amendment of S. 55:
In some of reported cases which have been decided after amendment of S. 55, prescribing cost as nil, the above contentions were not raised in relation to assets having no cost of acquisition. Therefore, Tribunal and High Court could not consider and decide the issue in light of above contentions.
Some important judgment on issue of cost of acquisition and cost of improvement:
In CIT V Pushpraj Singh (1998) 232 ITR 754 (MP the assessee acquired certain shares by way of transfer by the Government as a moral gesture. Those shares were sold. The assessee had not incurred any cost of acquisition, therefore, it was held that the sale price realized on transfer was not taxable as capital gain.
Route permits and improvement:
About route permits the AP High Court in case of Ganapathi Raju Jegi, [1979] 119 ITR 715 held that “ It is obvious that, at the time when a route permit is granted, no amount is paid by the operator for the purpose of acquiring it and it is only over a number of years that, because of various factors, viz., the development of the roads, the passenger traffic on the road, the frequency of the buses plying on the road, etc., that the route permit acquires some value. This case, therefore, is similar to the case of a transfer of goodwill where goodwill as such has no cost of acquisition, but at the time when the goodwill is transferred, it has come to acquire some value, particularly in the case of a business which has been started by the transferor himself.”
In this case in absence of cost of acquisition the sale value was held capital receipt and not profit or gain.
CIT Vs. Ganpati Raju Jegi 119 ITR 715 affirmed in [1993] 200 ITR 612 (SC) by holding as follows:
Case of land having no cost of acquisition:
CIT Vs H. H. Maharaja Sahib Shri Lokendra Singhji [1986] 162 ITR 93, 51 CTR 146, 25 TAXMANN 66
In this case after analysis of several judgment on issue of no cost no taxable capital gains the High Court observed as follows:
“It is no doubt true that none of these cases relate to the sale of immovable property as in the present case. But the gist of all these decisions has been the same that if there is no cost of acquisition, then the sale price would not attract the provisions of capital gains. Thus, it would be clear that the liability for capital gains tax would arise in respect of only those capital assets in the acquisition of which the element of cost is either actually present or is capable of being reckoned and not in respect of those assets in the acquisition of which the element of cost is altogether inconceivable, as in the present case.”
Commissioner of Income-tax v. Manoharsinhji P. Jadeja [2006] 281 ITR 19 (Guj)
In this case the property was acquired by forefathers by conquest and therefore there was no cost of acquisition, on transfer of such assets it was held that capital gains was not assessable and that provision deeming cost of acquisition at nil for purpose of computation applies only to specified items.
CIT Versus AMRIK SINGH (P & H) Reported at the website http://www.taxmanagementindia.com 2008 -TMI – 3681 their lordships SATISH KUMAR MITTAL and RAKESH KUMAR GARG JJ. Decide the matter in favor of assessee by confirming order of the CIT(A) and ITAT holding that when land was acquired by operation of law and the assessee had not incurred any cost of acquisition, the amount received on acquisition was not taxable u/s 45.
There have been many other cases on the same line in which this decision was followed.
Amendment has not made sale value taxable:
Now it is settled that consideration on transfer of tenancy right, goodwill, bonus shares, route permits, right to manufacture or any other capital asset cannot be brought to tax except under the head ‘capital gains’. Now the question arises as to whether the sale value of a tenancy right can be called ‘profit’ or ‘gain’ within the meaning u/s 45(1) merely because in section 55 cost of acquisition of such assets is prescribed to be nil.
To explain and examine this aspect we need to go through entire section 45. An analysis would show that under sub-section (1) any ‘profit’ or ‘gain’ is taxable, and this is the main charging section. Under sub-section (2) notwithstanding anything contained in sub-section (1) profit or gains arising from the transfer by way conversion by the owner of a capital asset or its treatment as stock-in-trade is made taxable as per prescribed method. Sub-section (3) prescribes taxation of capital gains on transfer of capital assets by a person to a firm or AOP or BOI (not being a company or a co-operative society). Sub-section (4) prescribes method of computation of capital gains arising from transfer of a capital asset by way of distribution of capital asset on dissolution of firm. Sub-section (5) prescribes about computation of capital gains in case of compulsory acquisition of assets in connection with the original amount of compensation receipt and additional or enhanced compensation receipt. Sub-section (6) prescribes for treatment as taxable capital gains of the repurchase price of units referred to any sub-section (2) of section 80CCB.
A close reading of section 45 provides that the subsection (2), (5), (6) starts with the phrase ‘not withstanding anything contained in subsection (1) ……….” This is because the items of capital gains referred to therein are not in nature of ‘profit’ or ‘gains’ or sometimes there may not be a transfer which is required under sub-section (1). The sub-section (2) makes certain transactions taxable even though there is no transfer and consideration is deemed as fair market value. It is found that in respect of subsections the method of computation is prescribed including interalia how the cost of acquisition and cost of improvement and consideration accruing is to be determined.
In sub-section (5) by way of an explanation it is mentioned as follows:-
Explanation.—For the purpose of this sub-section,–
(i) in relation to the amount referred to in clause (b), the cost of acquisition and the cost of improvement shall be taken to be nil,
This clause also clearly shows that the cost of acquisition and cost of improvement both are considered necessary ingredients to compute capital gains. This also shows that to make some capital receipt taxable as capital gain it is necessary to specifically provide in section 45, otherwise it was not necessary to mention in section 45 that capital value shall be taxable or that cost of acquisition and cost of improvement shall be taken to be nil for the purpose of S.45(5), by way of explanation.
There is no such provision prescribed in relation to sub-section (1) of section 45. Therefore, it is clear that u/s 45(1) what is taxable is only profit or gains arising from transfer of a capital asset and such profit or gain can be computed only after deducting cost of acquisition and cost of improvement both.
The meaning – u/s 55 for the terms the cost of acquisition and the cost of improvement are inserted for the purposes of section 48 and 49 and not for section 45 (1). For S. 45, if nil is to be taken it is specifically mentioned e.g. in sub section (5). Where capital value is taxable, it is specifically mentioned e.g sub-sections (6), therefore, for the purpose of section 45 if the cost of acquisition or cost of improvement is to be deemed as nil then there must be a specific provision in section 45(1) as is case in relation to section 45(5). Therefore, it can be said that the prescription u/s 55 that cost of acquisition or cost of improvement is nil is merely recognition of reality and the legal position in relation to section 45(1) is not changed.
In any case the cost of improvement of tenancy right cannot be ascertained and S. 55 (1)(b) does not provide that cost of improvement shall be considered nil in case of tenancy right, and cost of improvement cannot be computed as per S.55(1) (2). Therefore, sale value of tenancy right may not be taxable even from assessment year 1995-96 on wards.
Computation cannot be made by taking cost and cost of improvement as nil:
The scheme of tax on capital gains and its computation have salient features like:
the date of acquisition must be known so that nature of asset as to short term or long term can be ascertained.
The cost of acquisition, and cost of improvement and year in which such costs were incurred must be known so that computation of allowable inflated cost of acquisition and cost of improvement can be ascertained by applying relevant cost inflation index.
There is difference in amount of capital gains based on years of holding. Similar assets having similar cost , sold at the same time but acquired in different years will attract different computation mode and tax treatment. Because an asset can be short term, another can be long term asset held for say five years, and yet another asset held for say more than ten years. Thus the period of holding may vary which will have effect on allowable CII cost. As per computation provisions, gains in each case will be different because cost of acquisition / cost of improvement will have to be inflated with different CII depending on different years of acquisition or different period of incurring cost of improvement. This computation will not be possible in case cost of acquisition or cost of improvement is taken to be nil Because number of years for which the asset is held or number of years before which improvement took place will make no difference. Because in such case allowable cost of acquisition and cost of improvement, even after multiplication of CII factors shall remain nil. And in ultimate analysis sale value will be capital value.
There will be not tax on profit or gains because , sale value minus nil ( inflated cost of acquisition and cost of improvement) remains sale value or capital value, and that cannot be brought in taxable category u/s 45(1), and no other clause can be applied even after amendment of section 55.
As a computation as contemplated in the scheme of capital gains cannot be made distinguishing between short term capital gain and long term capital gain and also by differentiating amount of taxable capital gains based on period of holding, it cannot be said that a computation can be made as per the computation provisions and scheme of the Act. When a computation cannot be made as per computation provision the charge must fail. This is well settled in B.C.Sriniwasa Setty V CIT (1981) 128 ITR 294 (SC).
Therefore, it can be said that even after amendment of section 55 prescribing that cost of acquisition (for the purpose of section 48 and 49) shall be nil, it is extremely doubtful, whether sale value of such an assets can be brought in taxable capital gains category under section 45(1).
Word of caution:
In case of assets having no cost of acquisition or cost of improvement claim for exemption can be made, for consideration of the A.O. With a view to play safe it is desirable to include gains in income, and pay tax under protest and without prejudice so that matter can be carried in further appeal and clients do not loose the chance of claiming refund in due course if the courts decide in favor of any assessee.

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