The Hindu Business Line : Taxability of coupons, warrants and rights

Take, for instance, the case of Jannhavi Investments (P) Ltd which received bonus shares in 1981-82 and additional bonus shares in 1989-90 in Bharat Forge Ltd. These shares were held as stock-in-trade till November 1987.

When they were sold, the option to adopt the fair market value as on April 1, 1981, was denied as they were not capital assets on that date.

The Bombay High Court pointed out that there was no acquisition of the shares at the time of conversion from stock-in-trade to capital asset in November 1987. The company had received coupons along with non-convertible debentures. In the case of such coupons, there was no cost of acquisition.

Section 55(2)(aa) of the Income-Tax Act, 1961 was sought to be invoked by the Revenue in order to treat the cost of acquisition of coupons as nil. The High Court rejected this argument. Nothing was shown to prove that the coupons were a security within the meaning of Section 2(h) of the Securities Contracts (Regulation) Act, 1956.

Coupons may be a financial asset under Section 55(2)(aa)(iiia). This sub-clause was brought into force subsequently and would not govern the facts of the case. The High Court decided the issue (304 ITR 276 Bombay) in favour of the assessee (assessment year 1990-91).

New Ambadi Investments (P) Ltd claimed short-term capital loss of Rs 22,42,053 in respect of sale of Rs 43,535 rights to partly convertible debentures of EID Parry (I) Ltd at the value of Rs 5 to Tichai Investments (P) Ltd. These were the details:

Sale proceeds of 43,535 rights PCDs at Rs 5 to Tichai — Rs 2,17,675

Less: Notional cost of 43535 rights PCDs — Rs 24,59,728

Balance — Rs 22,42,053

According to EID Parry (I) Ltd’s rights offer, for every 10 shares held, PCD of Rs 150 is issued and this would be converted into one equity share of Rs 10 each, plus Rs 60 premium and balance would be the non-convertible debentures.

In view of 1:2 ratio as above, for every right the corresponding drop in the market value of the existing share would be Rs 28.25 x 2 = 56.50.

The company claimed the short-term capital loss on the ground that the resultant fall in the market value of existing shares should be deducted from the amounts received, relying on the Supreme Court’s ruling in the Dhun Dadabhoy Kapadia (63 ITR 651) case.

Negative value

For the Revenue, it was beyond imagination that any asset in the form of rights can have a negative value. The claim for short-term capital loss was negatived. The Madras High Court held that the company was entitled to deduct from the capital gain realised, the loss suffered by way of depreciation in the old share.

Commercial practice and ordinary prudence would have to be followed when making computation for business purposes. The company was entitled to claim the capital loss (assessment year 1994-95) that had arisen due to transfer of rights issue to partly convertible debentures (304 ITR 211 Madras).

Ajay Metha claimed short-term capital loss of Rs 4,32,000 on account of extinguishment of rights in share warrants. The claim was disallowed on the ground that warrants could not be treated as capital assets under Section 2(14) of the Act. The Tribunal ruled that warrants were in fact capital assets. There was extinguishment of rights in the warrant when Metha lost the rights attached to the warrant for exercising the option of subscription to the equity shares.

It was not a case of extinguishment of the asset itself. Relinquishment of the asset or extinguishment of any rights in it may not amount to sale but can be considered a transfer.

Section 48 however requires that there must be full value of consideration from which the cost of acquisition could be deducted for computing capital gains. No value was assigned in Metha’s case to the consideration received on the transfer of warrants.

The Tribunal ruled that capital loss could not be computed and Mehta was not entitled to claim deduction under the head “short-term capital loss” as the computation provisions relating to the short-term capital gain failed (assessment year 1996-97) (305 ITR AT 155).

Amendment of the law

Much has happened after the Supreme Court ruling on nil costs vis-À-vis capital gains. Section 55 (2)(aa)(ii) was brought into the statute book by Finance Act, 1994 w.e.f. April 1, 1995, enabling the Revenue to treat the cost of renunciation of a right as nil.

Finance Act, 1995 amended Section 55 (iia) w.e.f. April 1, 1996, to deal with additional financial assets. After these amendments, the Supreme Court’s ruling in the Srinivasa Setty and Dhun Dadabhoy Kapadia cases will have no application.

The cost of acquisition for any additional financial asset allotted without payment will have to be treated as acquired at nil costs.

(The author is a former Chief Commissioner of Income-Tax. blfeedback@thehindu.co.in)