In the last blog, we discussed the common corporate actions, the reasons a company may carry those out, and the implication on shareholders. In this piece, we will be breaking down corporate actions through the taxation angle. If you haven’t read the first blog in this series, please click here to read the same.
Before we begin, let’s take a minute to understand how equity shares are taxed. You can either incur capital gains or a capital loss on the sale of your equity shares (Profit/Loss on the sale of your shares). The capital gains are calculated by deducting the purchase cost from the sale value. The taxes are levied on these gains. There are no taxes on capital loss, and they are allowed to be set off against your gains, helping reduce your tax liability.
The tax on capital gains depends on their nature– they can either be short-term gains or long-term gains. The nature of capital gain is decided through the holding period (the number of days you held your shares) specified in the tax laws. For equity shares of a domestic company listed in a recognized stock exchange in India, the holding period is 12 months. Gains that are short-term in nature are taxed @15%, whereas long-term gains over one lakh are taxed at 10%.
Further, for unlisted shares of a domestic company and listed/unlisted shares of a foreign company, the holding period is 24 months. The tax rates also differ. Short-term gains will be taxed as per your tax slab in both cases. At the same time, long-term gains in the transfer of unlisted shares of a domestic/foreign company are taxed at 20% with indexation. Long-term gains from the transfer of listed shares of a foreign company are taxed on par with the listed shares of a domestic company. Indexation is a method of adjusting the purchase cost of your investments (in this case, shares) to factor in inflation. The indexation benefit helps you reduce your tax liability, helping you realize higher post-tax capital gains.
If you have followed till now, you would have noticed that the cost at which you purchase your shares and your shares sale price, along with the number of days you held them are of prime importance in determining your capital gains and, consequently, the tax liability applicable. Below we discuss the taxability aspect of the common corporate actions.
Buying shares can benefit you in two ways– most commonly through the capital gains, i.e., gains through the increase in the value of your investments or the dividend payments from the company. Beginning FY 2020-21, the dividend distribution tax was abolished, and the onus of paying taxes on dividends was shifted in the hands of investors. Earlier companies declaring dividends paid a dividend distribution tax before you got the dividend. Also, a tax of 10% was levied from resident individuals on dividends of over ten lakhs. Both of these provisions now stand abolished.
The dividend receipt is added to your income and taxed according to your tax slab. A TDS of 10% is also applicable on the dividend receipt if the payment is more than ₹ 5000. The company intimates you regarding the same on dividend declaration. You can submit forms 15G/15H to the company to avoid TDS deductions. In case your estimated annual income is below 2.5 lakhs, you can submit form 15G to avoid TDS on your dividend income and claim the full amount. The form 15H can be used if you are a senior citizen and have estimated your annual income tax liability as nil.
You can also claim a deduction for interest expense incurred on earning the dividend. For instance, if you took a loan for investing in the company’s shares. You can claim the interest paid on that loan as a deduction. However, the deduction cannot exceed 20% of dividend income.
Bonus shares are issued to the existing shareholders free of cost. While the bonus shares received at the time of issue aren’t taxable, the capital gains on the sale of bonus shares are taxable. On the sale of these shares, you can either incur a long-term capital gain or a short-term capital gain depending on your holding period. The period of holding and the capital gains are calculated separately for the bonus shares and the original shares (Shares that you owned before the bonus issue).
The period of holding for bonus shares is calculated from the date of allotment of the bonus shares. The capital gains calculation for bonus shares would take the cost of your acquisition of the shares as nil since the shares were acquired free of cost. Short-term gains will be taxed @15%, whereas long-term gains over one lakh at 10%.
Like the bonus issue, the shares received in rights aren’t taxed when you receive them. The capital gains tax arises on the sale of these shares. The period of holding and the capital gains are calculated separately for rights shares and the shares initially held by you. The period of holding for right shares will be taken from their date of allotment.
Shares received in a rights issue aren’t free of costs compared to a bonus issue. The cost of acquisition will be the price paid to acquire the rights. You can also add any monies paid to acquire the rights entitlement to your purchase cost while calculating the capital gains. As applicable, short-term capital gains or long-term capital gains will be taxed at the rates discussed above.
As discussed in the previous blog, a buyback is an exercise carried out by the company to buy its shares from the market. As an investor, you aren’t liable to pay any tax on income arising from a buyback. Buybacks are taxed at the company level. The company carrying out the buyback, whether listed or unlisted, is liable to pay tax at the rate of 20% on the distributed income. Hence, buybacks are favorable with respect to taxation for shareholders.
If you recall, a regular stock split increases the number of shares you hold and decreases the share price proportionately. The capital gains are calculated similarly but with a slight variation to the period of holding and the cost of acquisition. The period of holding for split shares is calculated from the date of purchase of original shares, unlike bonuses and rights. Further, the acquisition cost is divided proportionately between the original and split shares.
For instance, you purchased 50 shares of ABC Ltd. on 1/05/2020 for ₹1000 each. The company’s shares split on 2/07/2021 in the ratio 1:5, i.e., five shares for every 1 held– increasing your shares to 250. If you sold all your shares for ₹310 each, the period of holding for capital gains tax would be calculated from 1/05/2020 (a long-term gain in this case), and the acquisition cost would be adjusted to ₹200 per share (50*1000/250).
The capital gains would be calculated as ₹27,500 [(₹310*250) – (₹200*250)]. As the holding period is greater than 12 months, the gains are long-term in nature and taxable at the rate of 10% over 1 lakh. Hence, there will be no tax payable in this case.
Thank you for taking the time to read. Stay tuned for more blogs like these.
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– Nischay Avichal