NISM XB Short Notes – Part 11: Tax Provisions for Special Cases (Chapter 13)

NISM Series X-B Investment Adviser Level 2 | Special Cases Tax Notes | PassNISM.in

Part 11 of the NISM XB short notes series covers Chapter 13: Tax Provisions for Special Cases. These are corporate actions and special transactions that have unique income tax treatment — and are regularly tested in the NISM XB question bank.

1. Taxation of Bonus Shares

A company may issue additional shares to existing shareholders free of cost from its reserves — this is called a bonus issue.

Tax Treatment

No tax at the time of allotment of bonus shares — their cost of acquisition is treated as nil.
When the bonus shares are sold:
- If held as capital assets: Gains are taxable as capital gains (STCG or LTCG based on holding period from date of allotment).
- If held as stock-in-trade (in a trader's hands): Gains are taxable as PGBP.
Since cost of acquisition = nil, the entire sale price becomes the taxable gain for bonus shares held as capital assets.

Featured Snippet Answer: Bonus shares have nil cost of acquisition for tax purposes. When sold, the entire sale proceeds (minus any transfer expenses) are taxable as capital gains, classified as STCG or LTCG based on the holding period from the date of allotment. 2. Taxation on Stock Split / Share Consolidation

A stock split increases the number of shares while reducing the face value proportionately (e.g., 1 share of Rs 10 → 2 shares of Rs 5). A share consolidation (reverse split) reduces the number of shares and increases face value proportionately.

No tax at the time of split or consolidation — Section 47 does not specifically exempt these, but no transfer is deemed to occur.
The market cap of the company remains unchanged.
Tax implications arise only when the post-split/consolidation shares are eventually sold.
For holding period calculation: counted from the date the original pre-split shares were acquired.
For cost computation: original cost is apportioned across the new (post-split) shares.

3. Taxation of Buyback of Shares

Share buyback means the company purchases its own shares from shareholders. Post-2019 amendment:

Tax on buyback is paid by the company (Buyback Tax) at a specified rate on the distributed income (difference between buyback price and issue price).
In the hands of the shareholder, the buyback proceeds are exempt from capital gains tax (since the company has already paid the buyback tax).
Correspondingly, any loss arising from a buyback transaction is not allowed to be set off or carried forward in the shareholder's hands.

4. Taxation in Case of Company Liquidation

When a company is wound up (liquidated):

After paying all creditors, the remaining assets are distributed among equity shareholders.
For the company: Gains on disposal of assets may be taxable as business income or capital gains.
For the investor (shareholder): The amount received is treated as capital gains. The cost of acquisition is the original price paid for the shares. The holding period determines whether it is STCG or LTCG.

5. Taxation of Rights Issue

In a rights issue, a company offers existing shareholders the right to buy additional shares at a price lower than the market price, in proportion to their existing holdings. Shareholders can:

Exercise the right: Subscribe to new shares at the offered (discounted) price.
Renounce the right: Sell the right to another investor and receive a fee.

Tax Treatment

The right to subscribe is a capital asset in the hands of the original shareholder.
If the right is renounced (sold), capital gains arise. The cost of acquisition of the renounced right is nil (since it was received for free).
If the right is exercised, the cost of the new shares = the price paid to subscribe.
For the person who purchases the renounced rights and subscribes: the cost = amount paid to acquire the right + subscription price.

6. Taxation in Mergers and Acquisitions (Amalgamation)

In a merger (amalgamation), two companies combine either by forming a new entity or by one company absorbing the other. For tax purposes:

If the amalgamation satisfies conditions under Section 2(1B) of the Income Tax Act, the transfer is not regarded as a taxable transfer for the amalgamating company or the shareholders.
Shareholders receive shares in the amalgamated company in exchange for their original shares — this exchange is not taxable at the time of amalgamation.
When shares of the amalgamated company are sold later:
- Held as capital asset: taxed as capital gains.
- Held as stock-in-trade: taxed as PGBP.
The holding period of the original shares is included when determining STCG vs LTCG.

7. Taxation in Stock Lending and Borrowing (SLB)

Stock Lending and Borrowing is a mechanism where a shareholder (lender) lends shares to a borrower through an approved intermediary for a specified period. The borrower returns equivalent shares along with any corporate benefits (dividends, bonus) received during the period.

Tax Treatment

For the lender: The lending fee earned is income from other sources. The lending does not trigger a capital gains event.
For the borrower: Any gain or loss from selling the borrowed shares and repurchasing them is taxed as capital gains or PGBP, depending on how the activity is characterised.

8. Taxation on Conversion of Preference Shares into Equity

Section 47(xb) provides that conversion of preference shares into equity shares of the same company is not treated as a transfer — so no capital gains arise at the time of conversion.

However:

When the equity shares are subsequently sold, the cost of acquisition = cost of original preference shares.
The holding period of the equity shares is counted from the date the original preference shares were acquired (not from the conversion date).

9. Cost Inflation Index (CII)

The CII is notified by CBDT every year and is used to compute the indexed cost of acquisition and indexed cost of improvement for long-term capital assets.

Base year: 2001–02 (CII = 100).

The indexed cost formula:

Indexed Cost = Actual Cost × (CII of Year of Transfer ÷ CII of Year of Acquisition or 2001–02, whichever is later) Quick Revision Checklist — Special Tax Cases (NISM XB)

☑ Bonus shares: cost = nil; LTCG or STCG based on holding from allotment date
☑ Stock split: no tax; cost apportioned; holding period from original purchase
☑ Buyback: company pays buyback tax; shareholder exempt from capital gains
☑ Liquidation: shareholder receives = capital gains; cost = original purchase price
☑ Rights issue: right to subscribe = capital asset; renounced right's cost = nil
☑ Amalgamation: not a taxable transfer if conditions met; post-sale gains taxed
☑ SLB: lending fee = other sources income; no capital gain on lending
☑ Preference → Equity conversion: not a transfer; cost and holding period from preference shares
☑ CII: base year 2001–02; notified by CBDT annually

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