Earnings from equities are not limited to buying and selling stocks and any capital gains accrued from mutual funds. There are special transactions, too, such as Esop (Employee stock option) buybacks, bonus shares, rights shares, sweat equity shares, etc. It is therefore important that an investor understands how these different transactions are taxable. Importantly, investors should also be aware of how their income will be taxed in case of shares being split.
Sweat equity shares: These are shares issued at discount or for consideration other than cash to employees or directors of the company as reward for their hard work or for their value addition in the progress of the company. The shares thus provided will be taxable as a perquisite in the hands of employees in the previous year in which shares or securities are allotted or transferred to the employee.
Valuation of these shares, however, will vary for quoted and unquoted shares. Quoted shares are of the company that are listed on any stock exchange. The average of opening and closing price on the date of exercise is the fair market value of quoted shares. If the shares of a company are not listed on any stock exchange (unquoted shares), the fair market value will be determined by the merchant bankers on the specified date.
For instance, let us take the case of an employee who has been provided with stock options. The value of the stock on date of exercising the option was ₹100 and on the date of selling the share, it is ₹120. In this case, ₹100 will be taxable as ‘Income under the head salary’ and the balance ₹20 will be taxable as ‘Income under the head capital gains’.
Bonus shares: These are new shares issued to existing shareholders of a company. These shares are issued to the shareholders in proportion of their current holdings. The bonus share received will be taxable at time of sale and no tax will be levied at time of allotment of such shares. Also, it is important to note that cost of acquisition of bonus shares is taken as zero and, hence, the capital gain on selling a bonus share is equal to its selling price.
Further, as for the period of holding, it would be calculated separately for original shares and bonus shares. For bonus shares, the period of holding will begin from date of allotment of shares.
Rights shares: These provide rights to existing shareholders to acquire more shares in the company at a price which is lower than the current market price. Taxability of right share is divided into two parts: where the right is exercised or renounced.
Where the right is renounced, the amount received from renouncing right shares will be fully taxable and cost of acquisition for this purpose will be taken as ‘nil’. Generally, this type of gain is short term and, therefore, it is clubbed with other normal income and is taxed at normal slab rate.
Where the right is exercised, it will be taxable as if normal shares are purchased at discounted price, i.e. the cost for this purpose will be the exercise price paid.
Split share: Splitting a share is like dividing a single large piece into little small pieces. This division into multiple smaller shares does not result in an increase of market capitalisation. Cost of acquisition will be determined by dividing original cost with the total number of shares after spilt. For instance, consider that a person has 20 shares of ₹100 with face value ₹10 each. The period of holding in this case will be calculated from the date of acquisition of the original share.
Share buybacks: Many companies carry out share buybacks if in their view the share is undervalued. Taxation of such buybacks differs for listed and unlisted companies.
For shares of unlisted company, as per section 115QA of the Income Tax Act, the company will be required to pay a levy of additional Income-tax at the rate of 23.296% (taxed at 20% plus 12% surcharge and 4% cess) of the distributed income on account of buy-back of unlisted shares by the company.
As additional income-tax has been levied at the level of the company, the consequential income arising in the hands of shareholders has been exempted from tax under section 10(34A) of the Income Tax Act.
For shares of listed companies, taxation is simple. The amount received on account of buyback is the consideration amount and original acquisition cost is deducted from it.
Jigar Mansatta is proprietor at Jigar Mansatta & Associates.
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Published: 19 Dec 2023, 12:42 AM IST