Infosys announced a 1:1 bonus issue of shares on July 13, 2018, to commemorate the silver jubilee of the company’s public listing of its equity shares on Indian bourses. This would be the 12th 1:1 bonus issue from Infosys. A 3:1 bonus issue was announced in 2005. Shareholders in India consider a bonus issue of shares as a financial reward. In this instance, there is certainly a bonanza for the I-T department from the bonus shares issued to shareholders holding shares on before January 31, 2018.
Long-term capital gains (LTCG) arising from the sale of equity shares listed on Indian stock exchanges on which Securities Transaction Tax (STT) is paid was exempt from taxation up to March 31, 2018. To minimise economic distortions and curb erosion of tax base, LTCG arising from the transfer of equity shares exceeding Rs 1 lakh are taxed at a concessional rate of 10% from April 1, 2018.
To protect capital gains accrued up to January 31, 2018, from taxation, the actual cost of acquisition or the fair market value (FMV) of shares as on January 31, 2018, whichever is higher, would be considered as the cost of acquisition. But if the full value of consideration on transfer is less than FMV, then such full value of consideration or the actual cost, whichever is higher, will be deemed as the cost of acquisition. In case of a listed equity share, FMV means the highest price of such share quoted on a recognised stock exchange on January 31, 2018.
For computation of capital gains on sale of bonus shares, the cost of acquisition is deemed to be ‘nil’ and the period of holding is computed from the date of allotment of such bonus shares. Under the earlier tax regime, the entire capital gains on sale of bonus shares held for more than 12 months was tax-exempt, whereas it will be taxable under the current tax regime beyond Rs 1 lakh.
A comparison of taxation of capital gains without the issue of bonus shares and after the issue of bonus shares for shareholders holding equity shares on before January 31, 2018, would explain the consequences better. The 52-week low price of Infosys shares is Rs 860 and the current price is around Rs 1,350, and FMV of Infosys shares on January 31, 2018, was Rs 1,166. Assuming an investor purchased 200 shares at Rs 900 per share before January 31, 2018, and sold them at Rs 1,750 in 15 months from now, the capital gains computation would be as shown in the accompanying graphic.
Assuming bonus shares in the ratio of 1:1 are issued and the stock price is Rs 875 (half of Rs 1,750) 15 months from now (which would make Infosys bonus share a long-term capital asset), the total sale consideration on sale of all shares (original and bonus) would be Rs 3.5 lakh (same value if bonus shares are not issued). Capital gains are computed separately for original shares and bonus shares and would be as shown in the graphic.
Where the sale price (Rs 875) is lower than FMV on January 31, 2018 (Rs 1,166), the full value of sale consideration (Rs 875) or the actual cost of acquisition (Rs 900), whichever is higher, will be deemed to be the cost of acquisition. In this case, the sale price at Rs 875 per share is lower than FMV of Rs 1,166 per share. Hence, the sale price of Rs 875 per share or the actual cost of acquisition of Rs 900 per share, whichever is higher, would be taken as the cost of acquisition. This will result in a long-term capital loss of Rs 25 (Rs 875 less Rs 900) per share and the aggregate long-term capital loss on the sale of 200 original shares will be Rs 5,000 (see graphic).
Thus, the taxable capital gains under the current regime would be Rs 16,800 if no bonus shares are issued and Rs 70,000 if bonus shares are issued—a tax increase of more than four times. Infosys has frequently issued bonus shares in the past (13 times). A large number of Infosys shareholders currently hold bonus shares with a ‘nil’ cost of acquisition. The tax impact for those shareholders would be higher since there would no long-term capital loss from sale of bonus shares held on before January 31, 2018, to offset LTCG arising from the sale of the new bonus shares.
The income-tax law considers FMV as on January 31, 2018, only for computation of LTCG and not for long-term capital loss. If the Income-tax Act is amended to consider FMV for computation of long-term capital losses also (at least on issue of bonus shares), the tax impact would be similar as in the first instance where bonus shares are not issued. The aggregate LTCG on the sale of original and bonus shares would be Rs 1,16,800 and taxable capital gains would be Rs 16,800—similar to LTCG when bonus shares are not issued.
Considering that indexation benefits are not provided in the current tax regime in the computation of capital gains from sale of equity shares, it would be appropriate for the I-T department to consider the FMV of shares or the actual cost of acquisition, whichever is higher, in all circumstances. Without this change in tax computation, shareholders holding shares on January 31, 2018 may not find it feasible to accept bonus shares.
The e-voting for issue of bonus shares commenced on July 24 and ends on August 22, 2018. Considering the high capital gains tax impact, it remains to be seen if shareholders owning shares before January 31, 2018, would approve this bonus issue.
Author is a tax consultant