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