CHAPTER 6
TAXATION OF EQUITY PRODUCTS60
LEARNING OBJECTIVES:
After studying this chapter, you should know about:
Source of Income
Tax treatment of listed equity shares
Tax treatment of unlisted equity shares
Taxation of Preference shares
Taxation of GDR/ADR
Taxation of Warrants
Taxation in Equity Oriented Mutual Funds
Equity Derivatives
Dividend and Bonus Stripping
The equity market, often called a stock market or share market, is a place where shares of companies or entities are traded. The market allows sellers and buyers to deal with equity shares and other securities on the same platform. Equity share represents the ownership of a person in the company. Equity investments are generally considered as risky as compared to debt instruments. There are many types of equity-related products available in the market, but they are not the same. Tax rules applicable to these products also differ. Taxes can reduce the overall returns that an investor gets from a product. Thus, it is important to understand the taxability of equity products before investing therein.
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of FPIs and Specified funds, tax shall be charged at the concessional rate specified under Section 115AD. For taxability of these FPIs and Specified Funds refer Chapter 10 and Chapter 11.
60 In case
6.1 Sources of Income
An equity investment generally refers to the buying and holding of shares by an investor in anticipation of the return of income. Two types of income are earned from investment in equity products - Capital gains and Dividend Income. Capital Gains arise when a capital asset is sold at a price higher than its cost of acquisition. The dividend is the sum paid by the company out of its profits to shareholders which, in turn, reduce the retained profits of the company.
The taxability of both types of incomes has been discussed in detail in the forthcoming paragraphs of this chapter.
6.1-1 Dividend Income
Dividend usually refers to the distribution of profits by a company to its shareholders. The dividend is paid by a company out of its profits. Thus, a share of profit received by a shareholder out of the profits of the company, proportionate to his shareholding, is termed as ‘Dividend’.
Dividend declared at an annual general meeting is deemed to be the income of the previous year of the shareholder in which it is declared. The date of receipt by the assessee is not material. The interim dividend is deemed to be the income of the previous year in which the amount of such dividend is unconditionally made available by the company to the shareholder. In other words, it is chargeable to tax on receipt basis.
The tax treatment of the dividend in the hands of shareholders depends on whether the dividend is received from a foreign company or a domestic company.
6.1-1a Place of accrual of dividend
The dividend payable by an Indian company is always deemed to accrue or arise in India whether it is paid in India or Outside India. Thus, every person (whether resident or non-resident) is liable to pay tax in India on dividend distributed or paid by an Indian company.
Dividend paid by a foreign company outside India is not deemed to accrue or arise in India. It means a non-resident is not liable to pay tax on dividend received outside India from a foreign company. Dividend from foreign companies, even if it is operating in India, is taxable only if it is paid in India.
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TAXATION OF EQUITY PRODUCTS
6.1-1b Tax on dividend
Up to Assessment Year 2020-21, domestic companies and mutual funds were liable to pay Dividend Distribution Tax (DDT) on the dividend. Therefore, shareholders or unitholders were exempt from paying tax on the dividend income. After the abolition of dividend distribution tax by the Finance Act, 2020 with effect from Assessment Year 2021-22, if a company, mutual fund, business trust or any other fund distributes dividend to its shareholders or unitholders then such dividend income is taxable in the hands of such shareholder or unitholders. The taxability of dividend and tax rate thereon shall depend upon the residential status of the shareholders and quantum of income. In case of a non-resident shareholder, the provisions of Double Taxation Avoidance Agreements (DTAAs) and Multilateral Instrument (MLI) shall also come into play (See Paras 6.2-2 and 6.2-3 for taxability of dividend).
6.1-2 Capital Gains
Any profit or gain arising from the sale of a ‘capital asset’61 is chargeable to tax as a capital gain. Income from Capital Gains is computed as under:
Less:
(a) Expenses incurred wholly and exclusively in connection with transfer (xxx)
(b) Cost of Acquisition/Indexed Cost of Acquisition (xxx)
(c) Cost of Improvement/Indexed Cost of Improvement (xxx)
(d) Capital gain taxable under Section 45(4) which is attributable to capital asset remaining with the firm, AOP or BOI after reconstitution (xxx)
Less:
Exemption under Sections 54 to 54GB to the extent of the net result of above calculation
Short-term or Long-term Capital Gains
xxx
The capital gains from the sale of equity shares can be either long-term capital gains or short-term capital gains depending upon the period of holding of capital assets.
61 Refer Chapter 3 for meaning of ‘Capital Asset’.
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Particulars Amount Full Value of Consideration Xxx
TAXATION OF EQUITY PRODUCTS
The period of holding a capital asset is determined to classify it into a short-term capital asset or long-term capital asset. This distinction is important as the incidence of tax is higher on short-term capital gains as compared to the long-term capital gains. Generally, the period of holding of a capital asset is calculated from the date of its purchase or acquisition till the date of its transfer.
The rate of tax on capital gains differs according to the nature of capital gain. Long-term capital gains are taxable at concessional rates of 20% or 10%, as the case may be. Short-term capital gains are generally added to total taxable income and are chargeable to tax as per the tax rate applicable according to the status of the assessee. However, in a few cases, short-term capital gains are also taxable at concessional rates.
In this chapter, we will discuss the tax treatment of capital gains arising from the following equity products:
(a) Listed Equity Shares;
(b) Unlisted Equity Shares;
(c) Preference shares;
(d) GDR/ADR;
(
e) Warrants;
(f) Equity Oriented Mutual Funds; and
(g) Equity Derivatives.
6.2 Listed Equity Shares
Equity shares represent ownership of a person in a company. Any company offering its shares to the public for subscription is required to be listed on the stock exchange and has to comply with the conditions as provided in the SEBI (Issue of capital and disclosure requirements) Regulations, 2018 [commonly known as SEBI (ICDR), Regulations].
Listing of securities with stock exchange is a matter of great importance for companies and investors because this provides liquidity to the securities in the market. The two major stock exchanges of India in which shares of a company can be listed are the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).
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TAXATION OF EQUITY PRODUCTS
All vital concepts of the securities markets, whether relating to investment in listed shares or calculation of gains or calculation of tax from such gains have been discussed in the forthcoming paragraphs.
6.2-1 Charges & Taxes
Various taxes and charges are payable to purchase and sell equity shares through stock exchanges, which have been explained below.
6.2-1a Brokerage
Brokerage is charged by the share broker who maintains the share trading account of the investor. The amount of brokerage depends upon the broker and the nature of the order placed.
6.2-1b Security Transaction Tax
The securities transaction tax is a tax levied on sale/purchase of securities (other than debt securities or debt mutual fund). Every recognised stock exchange or trustee of a mutual fund or lead merchant banker (in case of IPO) is required to collect the STT from purchaser or seller of the securities, as the case may be, and, subsequently, remit the same to the Central Government. STT collected during a calendar month is required to be paid to the Central Government by 7th day of the month immediately following the said calendar month (Refer Annexure-H for the rates of STT).
6.2-1c Stamp Duty
Stamp duty is levied for transferring shares and securities from one person to another. Stamp duty is levied by States, thus, the rate of duty varies from state to state. However, with effect from April 1, 2020, stamp duty shall be levied at unified rates across India in respect of listed securities. The same rate shall apply even in case of off-market transactions (Refer Annexure-H for the rates of stamp duty).
6.2-1d Exchange Charges
This charge is levied by the stock exchanges of India. Transaction charges are levied on both sides of the trading and are same for both intraday and delivery. NSE and BSE charge a transaction fee of 0.00325% of the aggregate amount of purchase and sale, respectively.
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TAXATION OF EQUITY PRODUCTS
6.2-1e SEBI Turnover Charges
Securities Exchange Board of India (SEBI) is the security market regulator, which forms rules and regulations for the stock exchanges. A turnover charge of Rs. 10 per crore is levied by SEBI for regulating the markets. This charge is levied on both sides of the transaction, i.e., while buying and selling. A turnover charge of Rs. 2.5 per crore is levied on all purchase and sale transaction in debt securities.
6.2-1f Depository Participant (DP) Charges
NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited) are two stock depositories in India. The depositories hold shares and securities in electronic form on behalf of the shareholder and facilitate the exchange thereof between buyer and seller. When a person buys shares, such shares are credited in DEMAT account of that person and when he sells such shares, they are debited from his DEMAT account. Depositories charge Rs. 13.5 plus GST (irrespective of quantity) for this facility on the day the securities are debited from DEMAT Account.
The depository participants (i.e., broker) form the bridge between the investors and the depository as investors cannot directly approach the depository. Therefore, the depository charges a fee from the depository participant and who in turn, charge the investors.
6.2-1g GST
It is levied on the amount of brokerage, exchange transaction charges and clearing charges. At present, the GST is charged at the rate of 18% on the amount of brokerage, transaction and clearing charges.
6.2-2 Tax on dividend
6.2-2a
As per domestic laws
Dividend received by a resident shareholder is taxable in his hands at the applicable rates (for normal tax rates applicable in case of various persons, see Annexure-E). A resident shareholder is allowed a deduction of interest expenditure incurred to earn that dividend income to the extent of 20% of total dividend income. No further deduction shall be allowed for any other expenses including commission or remuneration paid to a banker or any other person for the purpose of realising such dividend.
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TAXATION OF EQUITY PRODUCTS
Where the dividend is received by a non-resident person or foreign company (including foreign portfolio investors (FPIs) and Non-resident Indian Citizens), the dividend shall taxable in their hands at special rates, subject to provisions of DTAA. In case of a specified fund, as referred to in section 10(4D), dividend income is chargeable to tax at a concessional rate of 10%. However, no expenditure shall be allowed to be deducted from such income. Further, deduction under Chapter-VIA, that is, Sections 80C to 80U, shall not be allowed from such income. The tax rates on dividend income shall be as follows:
6.2-2b As per DTAA
As per DTAA, dividend income is generally chargeable to tax in the source country as well as the country of residence of the assessee and, consequently, the country of residence provides a credit of taxes paid by the assessee in the source country. Thus, the dividend income shall be taxable in India as per provisions of the Act or as per relevant DTAA, whichever is more beneficial.
As per most of the DTAAs India has entered into with foreign countries, the dividend is taxable in the source country in the hands of the beneficial owner of shares at the rate ranging from 5% to 15% of the gross amount of the dividends.
In DTAA with countries like Canada, Denmark, Singapore, the dividend tax rate is further reduced where the dividend is payable to a company that holds a specific
62 Amendment made by theFinance Act, 2023 with effect from Assessment Year 2024-25.
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Section Assessee Income Tax Rate 56 Resident Dividend Applicable Rate 115A Non-resident or Foreign Company Dividend 10% if received from IFSC unit62 otherwise 20% 115AB Offshore fund Dividend from units of mutual fund purchased in foreign currency 10% 115AD FPIs Dividend income from any security (other than units referred to in Section 115AB) 20% 115AD Specified Fund Dividend income from any security (other than units referred to in Section 115AB) 10%
TAXATION OF EQUITY PRODUCTS
percentage (generally 25%) of shares of the company paying the dividend. However, no minimum time limit has been prescribed in these DTAAs for which such shareholding should be maintained by the recipient company. Therefore, MNCs were often found misusing the provisions by increasing their shareholding in the company immediately before the declaration of the dividend and offloading the same after getting the dividend. India did not face this situation as dividend income was exempt from tax in the hands of the shareholders till Assessment Year 2020-21. However, after the abolition of dividend distribution tax, India will face the risk of tax avoidance by the foreign company by artificially increasing the holding in the dividend declarant domestic company.
India is a signatory to the Multilateral Convention (MLI) which shall implement the measures recommended by the OECD to prevent Base Erosion and Profit Shifting. MLI is a binding international legal instrument that is envisaged with a view to swiftly implement the measures recommended by OECD to prevent Base Erosion and Profit Shifting in existing bilateral tax treaties in force. With respect to dividend income, Article 8 (Dividend Transfer Transactions) of MLI provides for a minimum period of 365 days for which a shareholder, receiving dividend income, has to maintain its shareholding in the company paying the dividend to get the benefit of the reduced tax rate on the dividend. However, this condition is applicable only if India and partner county have notified this clause. As of now 4 countries i.e., Canada, Montenegro, Slovak Republic and Slovenia have notified this clause.
6.2-3 Tax on inter-corporate dividend
The taxability of dividend has been shifted from companies to shareholders with effect from Assessment Year 2021-22. Therefore, in order to remove the cascading effect where a domestic company receives dividend from other domestic company, foreign company or business trust, a new section 80M has been introduced under the Income-tax Act to provide that inter-corporate dividend shall be reduced from total income of the company (computed under normal provision or alternative tax regime of Section 115BAA or Section 115BAB) if the same is further distributed to shareholders on or before the due date (i.e., one month prior to the due date of filing of return).
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Example 1: XYZ Ltd. borrowed Rs. 50 lakhs carrying interest rate of 7% per annum for the purpose of business. Out of the borrowed funds, Rs. 10 lakhs was lying unutilised, therefore, same was invested in equity shares of a company ABC Ltd.
During the financial year 2022-23, XYZ Ltd. received dividend of Rs. 3 lakhs in respect of investment made in ABC Ltd. It incurred an expenditure of Rs. 50,000 towards commission paid to banker for realising the dividend. The due date of filing of return for the financial year 2022-23 by XYZ Ltd. is 31-10-2023.
Compute the amount of dividend taxable in the hands of XYZ Ltd. and the deduction available under Section 80M in respect of inter-corporate dividend in the following scenarios:
(a) XYZ Ltd. distributed Rs. 2,00,000 as dividend to its shareholders in the month of August 2023.
(b) XYZ Ltd. distributed Rs. 1,00,000 as dividend to its shareholders in the month of August 2023 and Rs. 1,00,000 in the month of December 2023.
Answer
The dividend taxable in the hands of XYZ Ltd. and the deduction available under Section 80M in respect of inter-corporate dividend shall be computed as follows:
Scenario 1: XYZ Ltd. distributed dividend of Rs. 2,00,000 in the month of August 2023
† As dividend has been further distributed before the due date (one month prior to due date of furnishing return of income) deduction under Section 80M shall be allowed.
‡ As per proviso to section 57(i), expenses incurred as commission for realizing dividend is not allowed as deduction.
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Particulars Amount Dividend received from ABC Ltd. [A] 3,00,000 Interest incurred [B = 10,00,000 × 7%] 70,000 20% of dividend [C = 3,00,000 × 20%] 60,000 Interest allowable as deduction under section 57 [D = lower of B or C]‡ 60,000 Dividend taxable under the head other sources [E = A - D] 2,40,000 Deduction under Section 80M† [F] 2,00,000 Taxable income [G = E - F] 40,000
TAXATION OF EQUITY PRODUCTS
Scenario 2: XYZ Ltd. distributed dividend of Rs. 1,00,000 during the month of August 2023 and Rs. 1,00,000 during the month December 2023.
Interest allowable as deduction under section 57 [D = lower of B or C] ‡ 60,000
Dividend taxable under the head other sources [E = A - D] 2,40,000
Deduction under section 80M† [F] 1,00,000
Taxable income [G = E - F] 1,40,000
† As dividend has been further distributed on or before the due date (one month prior to due date of furnishing return of income) deduction under Section 80M shall be allowed. Dividend of Rs. 100,000 distributed in the month of December 2023 can be claimed as deduction in the subsequent year provided the company has earned dividend income in that year.
‡ As per proviso to section 57(i), expenses incurred as commission for realizing dividend shall not be allowable as deduction.
6.2-4 Period of holding
The tax treatment of gains or losses arising from the sale of listed equity shares depends upon whether the gains are long-term or short-term. Shares which are listed on the stock exchange in India are treated as a short-term capital asset if they are held for not more than 12 months immediately preceding the date of transfer. In other cases, they are treated as long-term capital assets.
6.2-4a Securities held in Physical Form
If listed shares or securities are sold through brokers, the date of the broker’s note is treated as the date of transfer, provided the contract is followed by delivery. Thus, the period of holding should be counted from the date of purchase to the date of the broker’s note.
In case the transaction takes place directly between the parties and not through the stock exchange, the date of the contract of sale as declared by the parties is treated as the date of transfer, provided it is followed by the actual delivery of shares and the transfer deeds63.
63 Circular No. 704, dated 28.04.1995.
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Particulars Amount Dividend received [A] 3,00,000 Interest incurred [B = 10,00,000 × 7%] 70,000 20% of dividend
3,00,000
20%] 60,000
[C =
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