Taxation of Bonus Shares: Key Legal Insights from Recent Rulings
Understanding the Tax Treatment of Bonus Shares
Bonus shares are a common feature in the Indian corporate landscape, where companies issue additional shares to existing shareholders without any additional cost. The tax treatment of these shares, however, has been a subject of debate and judicial scrutiny. The primary question is whether the receipt of bonus shares constitutes taxable income under the Income Tax Act, and if not, how the subsequent sale of such shares is taxed.
Receipt of Bonus Shares: Not Taxable as Income
Recent judgments by the Madras High Court have clarified that the mere receipt of bonus shares does not amount to taxable income under Sections 2(22)(b) and 56(2)(viia) of the Income Tax Act. In a notable case, the Madras High Court upheld the findings of the Income Tax Appellate Tribunal (ITAT), dismissing the Revenue’s appeal. The Court held that Section 56(2)(viia), which generally taxes certain receipts without consideration, does not apply to bonus shares. This is because bonus shares are not received as a gift or without consideration; rather, they are issued as a result of the shareholder’s existing investment in the company.
The rationale is that bonus shares are a capitalization of the company’s reserves and are distributed to shareholders in proportion to their existing holdings. Since the shareholder does not pay any additional amount for these shares, and the issuance is not a transfer of property without consideration, the receipt of bonus shares does not trigger a taxable event under the relevant sections of the Income Tax Act.
Taxation on Sale of Bonus Shares
While the receipt of bonus shares is not taxable, the sale of these shares can result in tax liability. The nature of this tax depends on whether the shares are held as an investment or as part of a business.
Capital Gains Treatment
If the bonus shares are held as an investment, any profit from their sale is taxed as capital gains under Sections 45 and 48 of the Income Tax Act. The cost of acquisition for bonus shares is determined by spreading the cost of the original shares over both the original and bonus shares, provided they rank pari passu. This principle was affirmed by the Supreme Court in the case of Commissioner of Income-tax v. Dalmia Investment Co. Ltd., where it was held that the cost of the original shares should be allocated to both the original and bonus shares.
Business Income Treatment
If the assessee is a dealer in shares and securities, the sale of bonus shares may be treated as business income under Section 28 of the Income Tax Act. However, there is no automatic presumption that bonus shares acquired by a dealer are part of the stock-in-trade. The burden of proof lies with the Revenue to establish that the shares were held for the purpose of the business. Absent such proof, the default assumption is that the bonus shares are capital assets, and any profit from their sale is taxed as capital gains.
Valuation of Bonus Shares
The valuation of bonus shares for the purpose of calculating capital gains is a critical aspect. The Madras High Court, in Madura Mills Company Limited v. Commissioner of Income Tax, Madras, held that the cost of the original shares should be spread over both the original and bonus shares if they rank pari passu. This ensures that the cost of acquisition is fairly allocated and prevents the artificial inflation of capital gains.
In summary, the receipt of bonus shares is not taxable as income, but the sale of such shares can result in capital gains or business income, depending on the nature of the holding. The cost of acquisition for bonus shares is determined by spreading the cost of the original shares, and the burden of proof for business income treatment lies with the Revenue.
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