Several Indian start-ups have investors based out of Mauritius and Singapore. In the recent past, many of the start-ups in India have proposed listing of their shares on Indian stock exchanges pursuant to initial public offering (IPO). If the price per share is high, the company chooses to reduce the price to make it affordable for small retail investors.
Bonus issue and stock split
The price per share can be reduced in two ways: either by way of bonus issue by the company or by way of sub-division of shares into shares of lesser face value (stock split). Both these options provide the desired result before listing, i.e. reducing price per share.
A company generally prefers bonus issue when it wishes to reward the existing investors and is generally driven by the commercial aspects. Bonus shares are issued to the existing shareholders by capitalising the reserves of the company. The share capital of the company will increase, and the reserves will get reduced to that extent. The face value of the shares remains same, the number of shares held by each shareholder increases and the price per share gets reduced.
The other option for a company is stock split. In stock split, the face value of the share gets reduced, the number of shares held by each shareholder increases and the price per share gets reduced.
Income tax consequences
Many Mauritius and Singapore investors enjoy the grandfathering benefit under the respective tax treaties in respect of shares acquired prior to April 1 2017 (Article 13 of the Double Taxation Avoidance Agreement between India and Singapore; Article 13 of the Double Taxation Avoidance Agreement between India and Mauritius). In other words, gains from alienation of shares acquired before April 1 2017 in an Indian company shall not taxed in India in the hands of such Mauritius or Singapore investor.
Under the income-tax laws, an important question arises: Whether the grandfathering benefit under the tax treaties will be available for the bonus shares or split shares issued after the cut-off date?
When a company splits its shares, it can be argued that no new shares have been acquired and it is merely the sub-division of existing shares. No fresh investment is made by the shareholders upon such stock split. Moreover, there is neither any increase in the share capital of the company nor is there any change in the rights of the shareholder. Therefore, the shares held post-split can be considered to have been acquired on the date of original shares only and will enjoy the grandfathering benefit under the tax treaty.
In case of bonus shares issued after April 1 2017, the Revenue may deny the grandfathering benefit under the tax treaty by arguing that the bonus shares are new capital assets and the date of acquisition is the date when the bonus shares are issued. Bonus share is seen as a distinct property comprising of additional rights, which comes into existence on the date of its issuance and not on the date of allotment of original shares. Said proposition has been upheld by the Indian Courts as well in some rulings (see CIT v. Chunilal Khushaldas  93 ITR 369 (Guj HC); Manecklal Premchand v. CIT  186 ITR 554 (Bom HC); Sanatkumar Jayantilal v. CIT (1995) 211 ITR 755 (Guj HC); CIT v. DV Paranjape (2014) 367 ITR 173 (Bom HC)) while deciding the date of acquisition of bonus shares.
Be that as it may, the shareholders may possibly argue that a share is a chose in action (Khoday Distilleries Ltd v. CIT  307 ITR 312 (SC)) (i.e. the bundle of personal rights over property which can only be claimed or enforced by action, and not by taking physical possession) and all the rights are acquired at the time of allotment of original shares.
Hence, the rights, which are already embedded in the original shares, are not getting increased by issuance of bonus shares. Moreover, the computation mechanism in the Indian domestic tax law relating to the cost of acquisition and period of holding of bonus shares, cannot be considered for interpreting the term ‘acquired’ used in the tax treaty.
While bonus shares are ‘allotted’ on a later date, such shares are not ‘acquired’ on the said later date in the context of the treaty. Rather, acquisition must be considered to have happened when the investment was made in the original shares. These arguments also draw strength from the Revenue’s Circular on the General Anti Avoidance Rules (GAAR).
As per the said Circular, the grandfathering benefit under GAAR available to shares acquired prior to April 1 2017 will also be available to bonus shares issued on such shares. Thus, effectively treating the bonus shares to have been acquired prior to April 1 2017 for purposes of application of GAAR provisions.
To achieve the stated objective of reducing the price per share, stock split and bonus issuance are two options. The former appears to be a better option from an income tax perspective. Claim of grandfathering benefit (under India’s tax treaties with Mauritius and Singapore) on bonus issuance after the cut-off date may entail legal battle before the courts. Needless to say, the choice between these options also requires analysis from corporate law and regulatory perspective.
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