When Bonus Shares are Paid Out Under Dividend

Under income tax laws in India, the topic of bonus shares being paid out under dividend is an important one, as it affects both companies and shareholders. In this article, we will delve into this issue, exploring the legal framework, tax implications, and other relevant considerations related to bonus shares and dividends.

Definition of Bonus Shares and Dividends

Firstly, it is essential to understand the definitions of bonus shares and dividends. Bonus shares are additional shares given to existing shareholders based on the number of shares they already own. These shares are provided free of charge, and the company’s reserves are used to issue them. On the other hand, dividends are a distribution of a portion of a company’s earnings to its shareholders. Dividends can be in the form of cash or additional shares.

Legal Framework for Issue of Bonus Shares

The issue of bonus shares is governed by the Companies Act, 2013, and the rules prescribed therein. Section 63 of the Companies Act, 2013, provides for the issue of bonus shares by a company out of its free reserves, securities premium account, or capital redemption reserve account. A company can issue bonus shares only if it has been authorized by its articles of association.

Tax Implications for Companies

From a tax perspective, when a company issues bonus shares, it does not incur any immediate tax liability. This is because the company does not transfer any assets to the shareholders when issuing bonus shares. Instead, the company capitalizes its profits or reserves to convert them into share capital. As a result, the bonus issue does not result in any cash outflow from the company, and therefore, it is not subject to income tax.

Tax Implications for Shareholders

For shareholders, the receipt of bonus shares has no immediate tax implications. This is because the issue of bonus shares does not result in any income to the shareholders. However, the tax implications arise when the bonus shares are sold or transferred. When a shareholder sells the bonus shares, the capital gains tax is applicable. The cost of acquisition of the bonus shares is taken as nil, and the holding period is calculated from the date of allotment of the original shares.

Bonus Shares and Dividend Distribution Tax (DDT)

The dividend distribution tax (DDT) is a tax imposed on companies in India at the time of the payment of dividends to shareholders. When a company declares and pays dividends, it is required to pay DDT at a specified rate. However, the DDT is not applicable when a company issues bonus shares instead of paying dividends in cash. This is because the issue of bonus shares does not involve any cash outflow from the company, and therefore, the provisions of DDT do not apply.

Tax Treatment of Bonus Shares Under the Income Tax Act, 1961

The Income Tax Act, 1961, contains specific provisions related to the tax treatment of bonus shares. As per Section 56(2) of the Income Tax Act, 1961, any property received by an individual or Hindu Undivided Family (HUF) for a consideration less than its fair market value is chargeable to income tax under the head “Income from other sources.” However, an exception is provided for the receipt of bonus shares by a shareholder of a company.

The receipt of bonus shares by a shareholder is not considered as a transfer and, therefore, is not subject to tax under the provisions of Section 56(2) of the Income Tax Act, 1961. This exemption applies to both individuals and HUFs. Consequently, the issue of bonus shares does not result in any tax liability for the shareholders.

Conclusion

In conclusion, the issue of bonus shares and dividends under income tax laws in India is guided by specific legal provisions and tax implications. Companies are allowed to issue bonus shares out of their free reserves, and the issue of bonus shares does not attract any immediate tax liability. For shareholders, the receipt of bonus shares does not result in any tax liability, and the tax implications arise only when the bonus shares are sold or transferred. The exemption provided under the Income Tax Act, 1961, ensures that the receipt of bonus shares is not subject to tax under the head “Income from other sources.”

Overall, the tax treatment of bonus shares and dividends is designed to provide clarity and consistency in the taxation of such transactions, facilitating ease of compliance for companies and shareholders alike. As always, it is advisable for companies and shareholders to seek professional advice to ensure compliance with the relevant laws and regulations.