The Hindu Business Line : I've a load of shares to sell

I HAD invested in 200 shares of a company on September 23, 2003, which allotted me 200 bonus shares on January 6, 2004. How will the capital gains tax be calculated if I unload the shares either in one go or otherwise?

A. Jayakrishnan, Chennai

Time was when the cost of bonus shares was determined on the basis of averaging. But not any longer. The bonus shares and the shares they sprang from are treated on a standalone basis.

A compartmentalised approach is what this means. While purists may cavil at such a treatment, the tax administration trots out simplicity as the virtue of such a regime. To be more specific, the cost of bonus shares is deemed to be nil.

If you are holding these shares in the physical mode, you can easily satisfy the taxman by proving which one you sold — original or bonus shares.

But in a depository mode where shares are fungible this distinction is not possible. The law therefore adopts the FIFO (first-in-first-out) method under the depository regime.

Suppose you sell 200 shares in the first instalment, you would be deemed to have sold the original shares. If such a sale takes place after one year of acquiring the original shares, the resultant gains would be treated as long-term capital gain.

Similarly, bonus shares too must be held for more than 12 months from the date of their allotment to invest them with the character of long-term capital asset. Short-term capital gains exposes one to the normal tax regime which has the maximum marginal rate of 30 per cent as the tax rate.

Long-term capital gains, on the other hand, beget a number of tax benefits. In particular, long-term capital gains from bonus shares — which are deemed to have cost nothing — would be taxed at just 10 per cent. One can also totally avoid tax liability on long-term capital gains by getting into one of the tax shelters. And do not forget, you could get exemption under Section 10(36) by just sitting tight for 12 months in case the share happens to be the BSE 500 index.

Futures fundas

AS A lay person, I would like to know a little about futures and options?

Shiela Rathi, e-mail

Futures and options are species of the broad genre derivatives. Derivatives are instruments that derive their value from their underlying securities. For example, the quotation in the cash market of a scrip will have a bearing on the speculative value of it in the futures and options market. But then the derivative market serves the interests of hedgers as much as it serves the interests of speculators.

The difference between futures and options is that while futures is a form of structured forward contract which has to be honoured on its maturity, options vests the holder with the right but not with the obligation to go through with the contract.

Suppose a person has bought the option to buy 100 Rs 10 share of a company, which is currently trading at Rs 100 each in the cash market, one month hence by paying a premium of Rs 5 per share. He would exercise this right if the price has moved beyond Rs 105 — 100 + 5 — per share. Because in that case, the cost per share effectively works out to Rs 105 a piece and the excess over it is his profit which he can book straightaway or later on. Anything less than Rs 105 would not interest him for obvious reasons. This exemplifies a speculative deal.

Let us take a transaction exemplifying a hedging deal. A person buys 100 shares at Rs 100 each in the cash segment. Now to hedge against the downside, he might as well sell forward one month hence at Rs 100 a each.

Should the quotation one month hence be Rs 90, he can still exit unscathed by selling the shares in the future segment at the agreed price of Rs 100. The resultant loss would of course accrue to the buyer of the future contract. In futures, there is no premium.

Options do involve payment of premium but the upfront investment is low vis-à-vis in the cash segment thus enabling one to invest in a larger number of shares than would be permitted in the cash segment.

Going big

I HAVE been dealing in shares all these years and filing return for capital gains for income from this. Now I am entering into a partnership for operating on a bigger scale both in the intraday and delivery markets. What should be the entry passed for intraday trades — net or gross and what impact it would have for the purposes of Section 44AB dealing with tax audit?

I. K. Patel, Vishakapatnam

The dividing line between dealing and investing in shares is rather thin despite several judgments of the apex court on the issue. FIIs have been latching on to the capital gains bandwagon though theirs admittedly is a business of dealing in shares. Perhaps you too have got away despite being in the business of `dealing' in shares by your own admission.

When you enter into partnership and start buying and selling on a larger scale and at greater frequency, it will clearly point to you being in business. Section 44AB requires tax audit if the turnover or gross receipts are in excess of Rs 40 lakh.

In my view, the purchases made for the day trading and sales made to square them off during the same day cannot be netted because, though your intention is to square off the a buy order with a sell order and vice-versa before the day ends, there is no commitment to do so.

In the event, in my view, your turnover has to be accounted for on gross basis taking you towards the magic figure of Rs 40 lakh much more rapidly than would be the case where you had the liberty to follow the netting method.

(ASK! Send in your queries on accounting, auditing, corporate law and taxation to ask@thehindu.co.in)

S. Murlidharan

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