APPLICABILITY OF SECTION 56(2)(vii) (c) OF INCOME TAX ACT, 1961 ON BONUS SHARES

[Mr. M. GOVINDARAJAN]

Section 56(2)(vii) (c) of the Income Tax Act, 1961 (‘Act’ for short) provides that any property other than immovable property-

1. without consideration, the aggregate fair market value of which exceeds Rs.50,000/-, the whole of the aggregate fair market value of such property;
2. for a consideration which is less than the aggregate fair market value of the property by an amount exceeding Rs.50000/-, the aggregate fair market value of such property as exceeds such consideration

shall be chargeable to income-tax under the head ‘Income from other source’.

Bonus shares

Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company's accumulated earnings which are not given out in the form of dividends, but are converted into free shares.

Issue

The issue to be discussed in this article is as to whether the receipt of bonus shares by an assessee from the company where he is a shareholder is to be treated as ‘income from other sources’ with reference to decided case laws.

Case laws

In PR. COMMISSIONER OF INCOME TAX CENTRAL, BANGALORE., THE DEPUTY COMMISSIONER OF INCOME TAX CENTRAL CIRCLE 2 (2) , BANGALORE. VERSUS DR. RANJAN PAI - 2020 (12) TMI 1078 - KARNATAKA HIGH COURT the Karnataka High Court considered the question - Whether under the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessing authority is not correct in determining the fair market value as per Rule 11UA of the IT Rules at Rs.12,49,00,000/-on 1,00,00,000 bonus shares received by assessee and bring the same to tax under the head income from other sources by holding that section 56(2)(v) and (vii) cannot be invoked by assessing authority even when the assessing authority has rightly invoked the said provision as all the ingredients are satisfied to invoke said provision?

The High Court analyzed the provisions of Rule 11UA and section 56(2) of the Act.   The issue of bonus shares by capitalization of reserves is merely a reallocation of the company’s funds. There is no inflow of fresh funds or increase in the capital employed, which remains the same. The total funds available with the company remains the same and issue of bonus shares does not result in any change in respect of capital structure of the company.  Thus, there is no addition or alteration to the profit making apparatus and the total funds available with the company remain the same. In substance, when a shareholder gets a bonus shares, the value of the original share held by him goes down and the market value as well as intrinsic value of two shares put together will be the same or nearly the same as per the value of original share before the issue of bonus shares.  There is no material on record to infer that bonus shares have been transferred with an intention to evade tax, which is the object of the provision in question.  The High Court held that the  Commissioner of Income Tax (Appeals) as well as the tribunal have rightly held that when there is an issue of bonus shares, the money remains with the company and nothing comes to the shareholders as there is no transfer of the property and the provisions of Section under Section 56(2)(vii)(c) of the Act

are not attracted to the fact situation of the case.

In DCIT, CIRCLE-16 (1) , NEW DELHI VERSUS SMT ARUNA CHANDHOK - 2023 (9) TMI 330 - ITAT DELHI, the assessee is an individual.  She filed her income tax returns for assessment year 2015 - 2016 on 16.10.2015.  In the said return she declared her income as Rs,8,56,57,000/- which includes her salary, income from house property, income from capital gains from other sources. The assessee received bonus shares and bonus units from two companies during the said assessment year. 

The assessee was issued with a show cause notice as to why the bonus shares and bonus units received by the assessee should not be made as addition under Section 56(2)(vii)(c) of the Act.  The assessee gave a reply to the show cause notice.  In the reply she contended that-

• the provisions of Section 56(2)(vii)(c)will not apply to bonus shares and bonus units as they are capitalized by the companies;
• The value of the shares would remain the same and there would be no increase in the wealth of the shareholders on account of bonus issue and his percentage of holding the shares in the company remains constant.
• pursuant to bonus shares and bonus units, the share / unit gets divided in the same proportion for all the shareholders.
• There would be no receipt of any property by the shareholder and what is received is only split shares out of her own holding.
• The market price of any share after the bonus issue gets reduced almost in proportion to the bonus issue and hence there would be no increase in the market value of shares held by the assessee pursuant to bonus issue.
• The overall wealth of a shareholder post bonus or pre bonus  remains the same.
•     She received no additional benefit or income on allotment of bonus shares because it is only a split of his total rights in the wealth of a company which remains the same even after bonus issue.

The Assessing Officer did not consider the reply filed by the assessee and add a sum of Rs.36,10,63,656/- treating the bonus shares and bonus units taxable under Section 56(2)(vii)(c) of the Act. 

Being aggrieved against the order of Assessing Officer the assessee filed an appeal before Commissioner of Income Tax (Appeals).  Before the Commissioner of Appeals the assessee submitted the following-

• There is no compulsion by the law that an assessee should sell his total holding immediately on allotment of bonus shares.
• The assumption of the Assessing Officer that the assessee would get double benefit is completely devoid of any merits and has no basis.
• No benefit is derived by a shareholder immediately on allotment of bonus shares.
• Allotment of bonus shares would not be income at all.
• The cost of bonus shares is NIL in terms of Section 55(2)(aa)(i) of the Act.

The Commissioner of Income Tax (Appeals) held that the addition made by the Assessing Officer is not sustainable.  The market price of any share after the bonus issue gets reduced almost in proportion to the bonus issue.  On the sale of original shares held by an assessee the assessee would incur a loss.  Further the cost of acquisition of bonus shares is NIL.  The Assessing Officer also erred in concluding that the provisions of section 55(2)(aa)(i) are not applicable in case of ascertaining the cost of acquisition of bonus shares. The Assessing Officer  failed to recognize the fact that had the legislature intended so, the exclusion would have been provided for non applicability of the provisions of section 55(2)(aa)(i) with respect to issuance of bonus shares to the transactions referred in section 56(2) of the Act.  The Commissioner of Income Tax (Appeals) accepted the submissions made by the assessee and allowed the appeal filed by the assessee and also set aside the addition made by the Assessing Officer. 

The Revenue filed appeal before the Income Tax Appellate order against the order of Commissioner of Income Tax (Appeals) (‘ITAT’ for short).  The ITAT held that the Commissioner of Income Tax (Appeals) has rightly appreciated the contentions of the assessee and its related legal position.  The ITAT allowed the appeal filed by the assessee and decided the case against the Revenue.