When Bonus Shares are Paid Out Under Dividend: Understanding the Income Tax Implications
In the context of a company's financial operations, bonus shares are additional shares given to existing shareholders without any additional cost. When a company declares a bonus issue, it effectively capitalizes its reserves and surplus to issue these shares. Under Indian company law, bonus shares are issued out of profits and/or free reserves built up over the years. However, when bonus shares are paid out under dividend, there are income tax implications that shareholders need to be aware of.
Legal Framework for Bonus Shares and Dividend under Indian Company Law
According to Section 63 of the Indian Companies Act, 2013, a company may issue fully paid-up bonus shares to its members out of its free reserves, securities premium account, or capital redemption reserve account. Moreover, as per Section 123 of the Companies Act, 2013, a company may declare dividends out of profits generated in the current financial year as well as undistributed profits of previous financial years. The declaration and payment of dividends are subject to certain conditions and restrictions as specified under the Companies Act.
Tax Implications for Shareholders Receiving Bonus Shares as Dividend
When shareholders receive bonus shares as a form of dividend, they may wonder about the tax implications associated with such a transaction. In India, the taxation of bonus shares received as dividend is governed by the Income Tax Act, 1961. The Act provides specific provisions for the taxation of bonus shares, which are based on the nature and timing of the issuance and receipt of such shares.
Tax Treatment of Bonus Shares Received as Dividend
1. Taxation at the Time of Bonus Issue
When a company issues bonus shares to its shareholders, these shares are not subject to any tax implications at the time of issuance. The receipt of bonus shares by shareholders is not considered as income, and therefore, it is not taxable under the Income Tax Act. The issuance of bonus shares is regarded as a capitalization of the company's profits and does not result in any direct cash flows to the shareholders.
2. Taxation upon Sale of Bonus Shares
The tax implications for shareholders arise when they eventually sell the bonus shares they have received. The tax treatment of such transactions is similar to the taxation of capital gains from the sale of equity shares. The cost of acquisition for bonus shares is considered to be nil since these shares were received without any additional cost. Therefore, the entire sale proceeds from the disposal of bonus shares are treated as capital gains.
3. Computation of Capital Gains
In the case of bonus shares received as dividend, the computation of capital gains involves determining the fair market value of the bonus shares at the time of their receipt. As per the Income Tax Act, the fair market value of bonus shares is considered to be the market value of the shares on the date of their issuance. This value becomes the cost of acquisition for the purpose of computing capital gains upon the subsequent sale of the shares.
4. Holding Period for Long-Term and Short-Term Capital Gains
The period of holding bonus shares is crucial in determining whether the resultant capital gains qualify as long-term or short-term in nature. If the bonus shares are held for a period exceeding 12 months from the date of their acquisition, any gains arising from their sale would be treated as long-term capital gains. In contrast, if the bonus shares are sold within 12 months of their acquisition, the resulting gains would be classified as short-term capital gains.
Tax Treatment of Issuing Company
From the perspective of the company issuing bonus shares, the amount of bonus issued to shareholders is not deductible as an expense for the purpose of computing the company's taxable income. The issuance of bonus shares does not result in any cash outflow, and it does not impact the profits of the company. Consequently, the company is not entitled to any tax benefits or deductions with respect to the issuance of bonus shares.
Conclusion
In conclusion, it is important for shareholders to understand the income tax implications associated with receiving bonus shares as dividend. While the issuance of bonus shares does not give rise to immediate tax liabilities, the eventual sale of these shares may attract capital gains tax. Shareholders should be mindful of the cost of acquisition and the holding period for the bonus shares, as these factors determine the nature and extent of the tax liabilities arising from the sale of shares.
The tax treatment of bonus shares received as dividend is consistent with the broader framework for the taxation of capital gains from the sale of equity shares. Shareholders should seek professional advice to ensure compliance with the relevant provisions of the Income Tax Act and to optimize their tax planning strategies in relation to bonus shares received as dividend. Understanding the tax implications of bonus shares is crucial for shareholders to make informed decisions and manage their tax obligations effectively.
