[Arjim Jain is a 3rd year B.A. LL.B. (Hons.) student at National Law University, Odisha]
The ruling in DCIT v. Smt Aruna Chandok rendered on 5 September 2023 by the Delhi Bench of the Income Tax Appellate Tribunal (“ITAT”) has shed light on a crucial aspect of taxation in India – the treatment of bonus shares under the Income Tax Act (“IT Act”). In this landmark decision, the ITAT has unequivocally stated that income tax is not chargeable on bonus shares under the heading “income from other sources.” This ruling has far-reaching implications for individual shareholders and investors in India, as it clarifies the taxation status of bonus shares and underscores the principles of fairness and equity in taxation. This post delves into the analysis of bonus shares, the ITAT’s ruling, and its implications.
Analysing Bonus Shares
Before delving into the intricacies of the ITAT’s ruling, it would be useful to analyse what bonus shares are and why they hold a special place in the corporate world. Bonus shares, also known as “scrip dividends or capitalization issues,” are additional fully paid up shares that a company issues to its existing shareholders without any cost. These shares are allocated to the shareholders in proportion to their current shareholdings. Bonus shares are typically issued out of the company’s retained earnings or free reserves and do not involve any cash outflow from the company. Instead, they represent a capitalization of profits and are a means for the company to reward its loyal shareholders.
The key aspect of bonus shares is that they do not result in any immediate financial gain for the shareholders. While their shareholding in the company increases, the overall wealth of the shareholders remains the same, as the market price of each share adjusts accordingly after the bonus issue. This is a fundamental principle of bonus shares – they are a reshuffling of a shareholder’s existing rights in the company’s wealth, and not an inflow of fresh funds or income.
The ITAT’s Ruling
In DCIT v. Smt. Aruna Chandok, an individual assessee had received bonus shares and bonus units from Tech Mahindra Ltd. and JM Arbitrage Advantage Fund-Bonus Options. The Assessing Officer (“AO”) sought to tax these bonus shares and units under section 56(2)(vii)(c) of the IT Act, claiming that the assessee had received a double benefit from them. However, the ITAT, in its wisdom, rejected the AO’s contention and upheld the principle that bonus shares do not constitute income for the recipient. The ITAT made several important observations in its ruling:
- Capitalization of Profits: The tribunal emphasized that bonus shares are issued solely out of the capitalization of existing reserves in the company. They do not involve any inflow of fresh funds or income to the shareholders. Therefore, treating them as taxable income is incorrect.
- Maintaining Shareholder Wealth: The ITAT pointed out that the overall wealth of a shareholder, both pre-bonus and post-bonus, remains unchanged. The market price of each share adjusts after the bonus issue, ensuring that the value of the shareholder’s holding remains the same. Hence, there is no additional benefit or income received by the shareholder due to bonus shares.
- Proportionate Split: Bonus shares are distributed to all shareholders in proportion to their existing holdings. This means that there is no transfer of property or receipt of any new asset by the shareholder. What the shareholder receives is a division of their own holdings.
- Misconception of Double Benefit: The tribunal criticized the AO’s assumption that bonus shares result in double benefits for the shareholder. It highlighted that the timing of selling shares is at the discretion of the shareholder, and there is no legal compulsion to sell immediately after receiving bonus shares. Therefore, the AO’s argument lacked merit.
The ITAT cited the Supreme Court’s decision in CIT v. General Insurance Corporation Ltd., which held that the issuance of bonus shares does not result in an inflow of fresh funds to the shareholders. It also noted that the market price of shares adjusts almost proportionally to the bonus issue, further confirming the absence of any additional benefit.
Section 55(2)(aa)(i) and Capital Gains
Another important aspect of the ITAT’s ruling is its interpretation of section 55(2)(aa)(i) of the IT Act, which deals with the cost of acquisition of bonus shares. The CIT(A) had pointed out that the AO erred in concluding that this provision does not apply when “determining the cost of acquisition of bonus shares.”
Section 55(2)(aa)(i) states that the cost of acquisition of bonus shares is nil. This provision recognizes the fact that bonus shares are essentially a capitalization of profits and, therefore, should not be considered as having a cost. The ITAT concurred with this interpretation and rejected the AO’s stance that section 55(2)(aa)(i) does not apply in the case of bonus shares.
The ITAT’s reliance on the decision of the Karnataka High Court in Principal Commissioner of Income Tax v. Dr. Ranjan Pai further solidifies the principle that bonus shares do not result in an inflow of funds to shareholders and, therefore, should not be taxed under section 56(2)(v)(c).
Taxation of Bonus Shares
To understand the implications of the ITAT’s ruling fully, it is essential to consider how bonus shares are taxed in India. Bonus shares can be subject to taxation in two distinct ways:
- Capital Gains Tax: If an individual holds bonus shares as an investment and subsequently sells them, any profit generated from the sale may be subject to capital gains tax under sections 45 and 48 of the IT Act. The specific tax rate depends on whether the shares are classified as short-term or long-term capital assets.
- Business Income Tax: If an individual’s primary business involves trading in shares and securities, the sale of bonus shares may be considered business income. In this case, the profits are taxed under the provisions of section 28 of the IT Act.
The crucial point to note is that the taxation of bonus shares depends on the intent and nature of the holding. If the shareholder treats bonus shares as investments and holds them for the long term, capital gains tax is applicable. On the other hand, if the shareholder is engaged in the business of trading in shares, the profits may be treated as business income. The ITAT’s ruling primarily addresses the misconception that bonus shares should be taxed as income from other sources under Section 56(2)(ii)(c) of the IT Act. It clarifies that bonus shares are not income and should not be subject to taxation under this section.
The recent ruling by the Delhi Bench of the Income Tax Appellate Tribunal is a significant development in the realm of taxation in India. It provides much-needed clarity on the treatment of bonus shares under the Income Tax Act, emphasizing that they do not constitute income for the recipient. Instead, bonus shares represent a capitalization of profits and a reshuffling of existing rights in the company’s wealth.
This ruling is not only consistent with established legal principles but it also upholds the principles of fairness and equity in taxation. It ensures that individuals who receive bonus shares are not unduly burdened with additional tax liabilities for a transaction that does not result in any immediate financial gain.
As investors and shareholders navigate the complexities of the tax landscape in India, they can take solace in the fact that bonus shares are not subject to income tax under the head “income from other sources”. This clarity not only benefits individual taxpayers but also promotes a more transparent and equitable taxation system in the country.
– Arjim Jain