Treatment of Fractional Entitlement of shares under Income Tax Act

Hi all !!

This is perhaps my first post on Income tax matter, something for which I have actually created this blog

In the course of discussion on various tax matters with article students from our office some questions were discussed in the last week.. they were

1) What is the treatment of fractional entitlement received in cash in respect of bonus shares.?? ( or share split)

2) What amounts to 'turnover' if a person is dealing in shares (a) with delivery (b) without delivery??

3) Whether conversion of preference shares into equity shares amounts to transfer resulting into capital gain??

I thought it would be better if I gave my answers to these questions in separate posts, so that I can cover the issues involved therein at reasonable length..

In this post therefore, I am dealing only with the first question as to what is the treatment of fractional entitlement received in cash in case of issue of bonus shares / Share Split.

Comments:

(a) Bonus Shares

Bonus shares are the shares issued without any payment and on the basis of holding of other financial assets [i.e.Existing shares].. When a company issues bonus shares, the existing shareholder is allotted additional shares without payment, depending upon his holding of the existing shares on record date and bonus ratio. It may often happen that, shareholder's entitlement of bonus shares may not be in round number and hence in such a case entitlement to the extent of round number is given to the shareholder in the form of 'shares' and balance or fractional entitlement is paid to him in 'cash'..

It is to be noted that such cash is paid not out of companies own resources. All the fractional entitlements belonging to various shareholders are accumulated (which comes to a round number) and are then sold in the market; distributing proceeds thereof to eligible shareholders as per their fractional entitlement.. ( there is thus no release of assets of the company, the question of treating such fractional entitlement as 'dividend' within the meaning of Sec 2(22) does not arise). Thus there is 'transfer' of bonus share equivalent to cash entitlement.

The question then arise whether such fractional entitlement be treated as 'Income from other sources' or 'capital gain'.

The issue is dealt with by Hon'ble Mumbai Tribunal in the case of Shri Kiran Nagji Nisar vs ITO (2008) 300 ITR 286

In this case, Tribunal held that

"..profits on sale of bonus shares received by the assessee is taxable under the head 'Income from capital gain' and hence we are of the considered opinion that this receipt on account of 'fraction entitlement' is also taxable under the same head.."

Tribunal however does not deal with the question whether such capital gain is to be treated as short term or long term!!

It goes without saying that once fractional entitlement is considered as capital asset, it must be treated similar to bonus shares in this case and hence, Explanation 1 (i) (f) of Sec 2(42A) will come into play for the purpose of determining its period of holding and consequently the period of holding shall be reckoned from date of allotment of such bonus shares.

The cost shall be taken as Nil pursuant to Sec 55(2)(iiia) of the Act and the cash received against such fractional entitlement shall be treated as 'sales consideration'.

In short, entire sales consideration shall be treated as Short term capital gain in the hands of shareholder.

(b) Share Split

The concept remains the same, in case the fractional entitlement arises during share split.. the capital gain may also arise in this .. The period of holding will be the date on which such shares are purchased and FIFO principle will be applicable ( as the shares with Old FV in this case will be in DEMAT form). For the purpose of ascertainment of cost sec 55 (2) (b) (v)(d) will be applicable according to which cost will be same as the cost of acquisition of Old shares. To illustrate consider the following example:

Original FV of Shares: 10

Number of shares: 5 Nos

Total Cost : Rs.50

New FV of shares: 6

Number of Complete shares allotted: 8 Nos

Cost of fractional entitlement calculated w.r.t. Old shares = (Rs.50 - Rs.48) = Rs.2

Sale consideration shall be the amount received in cash.

In short there will be long term or short term capital gain depending upon the period of holding.

Hope the above explanation will suffice.

- CA mandar telang

Sec 3 (1)(iii) Definition of Private Limited Company and Sec 58A of Companies Act

Hello Everyone !!

Recently I came across an interesting question as to whether private limited company can accept corporate deposits?

The matter is interesting especially in the light of the fact that, Sec 3(1)(iii) that defines 'Private Ltd Company' expressly prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives. On the Other hand, Sec 58A that provides for invitation for the purpose of acceptance of deposits by company, defines the term 'deposit' as not to include, inter alia any amount received by a company from any other company. This definition is given in Rule.2(b) of Companies ( Acceptance of Deposits ) Rules, 1975 and is 'exhaustive' in nature. The question is, whether in the absence of definition of 'deposit' in Companies Act, 1956, is it possible to interpret Sec 3 (iii)(d) in the light of 'deposit' as defined in Sec 2(b) of Companies ( Acceptance of Deposits ) Rules, 1975.

My Opinion on the above query is as follows:

Sec3 deals with definitions of company. Sec 3 (1)(iii) which defines 'private company' was amended by Companies (Amendment) Act, 2000 w.e.f 13-12-2000 to include an additional condition i.e clause (d) which reads as follows:

'(d) prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives:'

In view of this specific ammendment, private ltd company can neither ' invite' nor 'accept' any deposit from persons other than its members, directors or relatives. Thus, in other words it can accept the deposit only from the above persons ( hereinafter referred to as 'specified persons').

Sec58A read with Companies ( Acceptance of Deposits ) Rules, 1975 lays down certain conditions to be complied before accepting deposits. Following points are relevant in this matter:

• Sec 58A is not applicable to all 'deposits'. Rule 2 (b) gives exhaustive definition of the word 'deposit' as it uses the word 'means'. It however excludes certain payments received by the company. Such exclusions include, inter alia,

(iv) any amount received by a company from other company

(ix) any amount received by a private company from a person who at the time of the
receipt of the amount, was a director, relative of director or member..

• Sec 58A (1) empowers Central Government to frame rules as regards invitation or acceptance by the company of deposits from the public or from its members.

It is the cardinal principle of law that, whenever there is ambiguity and more than one interpretation is possible, attempt should be made to interpret the law in an harmonised manner and the interpretation that would render some of the words redundant should be avoided.

Two views are possible in this case:

First View: Companies Act does not contain definition of 'deposit'. However, aforementioned Rules dealing with invitation or acceptance of deposits contains a specific definition. The definition can therefore be used while interpreting provisions of Sec 3 (1)(iii)(d). Since in the said definition amount received by a company from other company is excluded, a private limited company can accept the deposits from other company.

Second View: In view of specific prohibition in sec 3, private ltd company can not be permitted to accept deposits from persons other than specified persons.

I support the second view for the following reasons:

Sec 58A(1) does not expressly provide that, it is not applicable to private company. However the aforementioned exclusions from the definition of the term 'deposit' clearly indicate the intention of the legislature.

As per sec 58A(1), rules can be framed for acceptance of deposits from 'public' or 'members'. However, amount received by a private company from its members, directors or relatives are not to be treated as deposits at all. Since, this is the only source a Private limited company can accept deposits from, a view is possible that Sec 58A does not apply to Private Company.

First view, according to me is grossly erroneous. If we accept the first view, then it will make the condition imposed in Sec3(1)(iii)(d) absolutely redundant.This is certainly not the intention of legislature especially in the light of the fact that, Sec 58A was inserted by Companies ( Amendment) Act, 1974 ( w.e.f 01-02-1975), whereas the additional prohibition is inserted recently, in the year 2000. In the absence of such amendment to Sec 3 (1)(iii), Private limited companies were earlier in a position to accept deposits from public and hence Sec 58A was applicable to them in respect of deposits accepted from persons other than members, directors, relatives or other companies. But now the impact of amendment is that, private limited companies are absolutely barred from inviting or accepting deposits from persons other than specified persons and hence Sec 58A is not applicable to Private companies.


Thus in my opinion,

(1) Private limited companies cannot invite or accept corporate deposits except from companies which are its members

(2) Provisions of Sec 58A and Companies ( Acceptance of Deposits ) Rules, 1975 are not applicable to Private Limited Companies after the ammendment in sec 3 w.e.f. 13-12-2000.

Hope the above discussion will clarify the legal position.

- Mandar Telang.

Concession Agreements - Concept of 'BOT'

Hi there!!

Recently I am working on a matter where I am introduced to the concept of 'concession agreement'. Surprisingly, there are OECD guidelines on laws relating to Concession, something I was never aware of till yesterday.

Before we analyse the concept of concession agreement from Income Tax and service tax point of view, it is very necessary to throw some light on the general concept of Concession Agreement

It is an agreement meant to deal with BOT arrangements. BOT stands for "Build, Operate & Transfer" ..Two parties involved here are 'Concession Authority' i.e. party that gives the concession and 'Concessioner' i.e party that enjoys the concession. This concession is given w.r.t a specified asset and for a specified period known as 'concession period'.

In a typical BOT arrangement, Concession Authority provides the Concessioner land or site owned by it for the purpose of constructing thereon an asset or project for the benefit of third party. The project is constructed as per the instructions given and design specifications given by the former. Concession Authority does not spend or invest anything on the construction of the project except by providing its land for the purpose of the project. All the initial investments in the project are made by Concessioner. Once the construction of project assets is complete, the ownership of the entire project vests in Concession Authority. On the other hand its possession and right of operate and retain the revenues arising therefrom vest in the Concessioner. This right is known as concession and it is given to the Concessioer for concession period. A right to operate the project is also accompanied by a responsibility of maintaining the project and serving the beneficiaries. The revenues arising from the project are earmarked for the initial investments in the project and the cost of running and maintaining the project. In short in BOT arrangements, Concessioner builds the project assets, operate it and enjoys the revenues therefrom during the concession period and at the end of such period hand overs or transfers the entire project to its owner i.e. Concession Authority.

Concession Agreements are available in various forms like build - operate -transfer, Build - lease- operate-hand over, Build - own -operate - transfer etc. Here the concession authority is interested in the construction of project and control thereon in the form of ownership. Whereas the Concessioner is interested in recovering its entire initial investments, operating costs and earning a reasonable rate of return at the end of concession period.

The arrangements are common in Government projects. Ex: Construction of roads, bridges where tolling rights are given to the Constructor for 10-15 years.

Given above is a brief description of simple form of BOT arrangement. More information on various types of BOT arrangement is easily available on Internet. Thanks to Google..! But I feel this basic introduction is sufficient for us to proceed with the analysis of concession agreements from tax point of view.. I promise, I will soon come up with some interesting stuff on this matter.

- mandar telang.

Objective

I personally believe that my introduction is not really necessary at this moment.. 15 minutes before I was not even aware as to how to create a blog ... But I felt this is something that can help me in giving words to my thoughts
I am not much of a writer kind of person.. but I feel writing on this blog will give me an opportunity to share interesting information with you on tax related matters ( preferably income tax ) and will also indirectly facilitate my learning of income tax...
Don't know how often I am gonna update this blog... but my sincere efforts will be to prevent this blog from becoming a History..
Hope I will be able to do justice to the topic I have selected..