Accounting in case of capital reduction in shares
This query is : Resolved
11 June 2014
A person has the following shares of a Company :-
(1)36 shares @ 249.51 Total Cost - 8982.36
(2)200 shares @ 660.97 Total Cost - 132194.00
(3)708 Bonus Shares Total Cost - 0
TOTAL 944 Shares
All these shares were of face Value Rs.10.
However, recently , the Company did Capital Reduction & reduced Face Value of every Share to Rs. 5. As a result , the person received Rs.5 x 944 shares = Rs. 4,720 from the Company .
What would be the correct way (According to the Indian Income Tax Rules ) to account for this Rs. 4,720 in books of Investor ?
(1)36 shares @ 249.51 Total Cost - 8982.36
(2)200 shares @ 660.97 Total Cost - 132194.00
(3)708 Bonus Shares Total Cost - 0
TOTAL 944 Shares
All these shares were of face Value Rs.10.
However, recently , the Company did Capital Reduction & reduced Face Value of every Share to Rs. 5. As a result , the person received Rs.5 x 944 shares = Rs. 4,720 from the Company .
What would be the correct way (According to the Indian Income Tax Rules ) to account for this Rs. 4,720 in books of Investor ?
13 June 2014
There are two instances:
1. Shares are kept as Investments
In this Case there shall be no adjustment in cost of shares/investments at year ends. At the time of sale STCG/LTCG or STCL/LTCL shall be calculated in normal manner according to sale proceeds of shares.
2. Shares are kept as Stock in Trade
In this case, Section 145A of Income Tax Act shall be applicable which states that Inventories are to valued as per accounting Method employed by the Assessee. Now as per AS-2 Closing stock is to be valued at lower of Cost or Net Realizable Value (NRV). Hence, value of your shares shall be adjusted at year end if NRV is lesser then cost. At the time of sale of Shares business profits shall be calculated on the basis of sale value and stock value.
Income tax law nowhere determines adjustment/accounting for cost of shares in case of capital reduction is done by company whose shares are bought by the assessee.
1. Shares are kept as Investments
In this Case there shall be no adjustment in cost of shares/investments at year ends. At the time of sale STCG/LTCG or STCL/LTCL shall be calculated in normal manner according to sale proceeds of shares.
2. Shares are kept as Stock in Trade
In this case, Section 145A of Income Tax Act shall be applicable which states that Inventories are to valued as per accounting Method employed by the Assessee. Now as per AS-2 Closing stock is to be valued at lower of Cost or Net Realizable Value (NRV). Hence, value of your shares shall be adjusted at year end if NRV is lesser then cost. At the time of sale of Shares business profits shall be calculated on the basis of sale value and stock value.
Income tax law nowhere determines adjustment/accounting for cost of shares in case of capital reduction is done by company whose shares are bought by the assessee.
13 June 2014
So , according to you , how will the entry be passed for the Rs. 4720/- rcvd from the Company in Books of Investor ?
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13 June 2014
there is no monetary transaction involved here. as only the 944 shares were converted into 4720 shares
adjustment is required only if the shares are kept as stock which would be automatically done at the time of valuing the closing stock
for eg if i have 200 shares which the company made it to 400
suppose cost of my 200 shares was Rs.5000
i.e Rs. 25 per shares
now the cost would be Rs.5000 for 400
i.e Rs. 12.5 per shares
here there is no monetary transaction
but if its stock in trade then also the value of closing stock will be same
suppose on the last day of FY in stock exchange value of 200 shares is Rs.6500/-
now the same has been split the value of 400 shares would be 6500/-
now considering it as stock you will take Rs.5000 only as per Accounting Standard (5000 or 6500 which ever is lower)
so ultimately there is no adjustment required only thing is your qty of shares has increased which in turn have reduced your cost per share
adjustment is required only if the shares are kept as stock which would be automatically done at the time of valuing the closing stock
for eg if i have 200 shares which the company made it to 400
suppose cost of my 200 shares was Rs.5000
i.e Rs. 25 per shares
now the cost would be Rs.5000 for 400
i.e Rs. 12.5 per shares
here there is no monetary transaction
but if its stock in trade then also the value of closing stock will be same
suppose on the last day of FY in stock exchange value of 200 shares is Rs.6500/-
now the same has been split the value of 400 shares would be 6500/-
now considering it as stock you will take Rs.5000 only as per Accounting Standard (5000 or 6500 which ever is lower)
so ultimately there is no adjustment required only thing is your qty of shares has increased which in turn have reduced your cost per share
13 June 2014
Der Mr. Jignesh,
I replied your query earlier in a little hurry, but when you asked me question again about treatment of amount received I again went through your question and I had to study very hard for replying to your query.
This transaction has a very technical treatment in income tax. There is a Supreme Court judgment applicable to this case. Copy of judgment is enclosed. Sec 2(22)d of Income Tax is also applicable which read as under:
“Section 2(22) in The Income- Tax Act, 1995
Dividend includes:
(d) any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st day of April, 1933 , whether such accumulated profits have been capitalised or not;”
Accordingly, we will have to find out total amount distributed by company and accumulated profits of the company. Amount received to the extent of accumulated profits shall be considered as deemed dividend and amount in excess of that shall be chargeable to capital gain. In your case, to avoid complications and due to lack of data let us assume that company didn’t had any accumulated profits and hence whole amount distributed by it is chargeable to capital gain in hand of shareholders, in that case, Cost of amount received Rs. 4720 shall be 5/10 x 100=50%
50% of (8,982.36+1,32,194+0)=70,588.18
You may index this amount according to year of purchase. If 36 and 200 shares are purchased in different year, then 50% of both the amounts shall be indexed separately for two years. Hence Long term capital loss shall be there in your case.
It seems very strange that so much amount shall be booked as loss but it is the real treatment as provided by law. I had to go through my CA final Books again to find exact treatment of the query. Any CA final student may confirm the treatment by referring above mentioned section and judgment.
Thanks!
I replied your query earlier in a little hurry, but when you asked me question again about treatment of amount received I again went through your question and I had to study very hard for replying to your query.
This transaction has a very technical treatment in income tax. There is a Supreme Court judgment applicable to this case. Copy of judgment is enclosed. Sec 2(22)d of Income Tax is also applicable which read as under:
“Section 2(22) in The Income- Tax Act, 1995
Dividend includes:
(d) any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st day of April, 1933 , whether such accumulated profits have been capitalised or not;”
Accordingly, we will have to find out total amount distributed by company and accumulated profits of the company. Amount received to the extent of accumulated profits shall be considered as deemed dividend and amount in excess of that shall be chargeable to capital gain. In your case, to avoid complications and due to lack of data let us assume that company didn’t had any accumulated profits and hence whole amount distributed by it is chargeable to capital gain in hand of shareholders, in that case, Cost of amount received Rs. 4720 shall be 5/10 x 100=50%
50% of (8,982.36+1,32,194+0)=70,588.18
You may index this amount according to year of purchase. If 36 and 200 shares are purchased in different year, then 50% of both the amounts shall be indexed separately for two years. Hence Long term capital loss shall be there in your case.
It seems very strange that so much amount shall be booked as loss but it is the real treatment as provided by law. I had to go through my CA final Books again to find exact treatment of the query. Any CA final student may confirm the treatment by referring above mentioned section and judgment.
Thanks!
13 June 2014
Could not find option to add attachment, so link is copied below:
http://indiankanoon.org/doc/1984944/
http://indiankanoon.org/doc/1984944/
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14 June 2014
I will call up the Legal / Acct. Dept.of the Co. on Monday & find out whether the amount was paid out of accumulated profits or Capital .
(1) If paid from accumulated profits , the amount has to be treated as Dividend & credited to Dividend Received A/c .
(2) If paid from Capital (Not from accumulated profits) , then it has to be treated as Capital Gain .
Now,Yogesh , is my understanding perfect ?
There is still 1 question( This is in case it is to be treated as Capital gain) :-
The purchase date for all shares is before more than 1 year from receipt of the Rs. 4720 . So it is LTCL (For Shares , "Long Term" is defined as period of more than one year) .And Since LTCG on Shares is exempt from Tax u/s 10 , can Indexation be applied to the Cost ?
Anyway , either way , finally , this amount will be clubbed to the amount that is shown as exempt income u/s 10 in the Income Tax Return . Only difference is , if it is considered as Dividend , it will be clubbed to the amount shown as exempted u/s 10(34/35) & if it is LTCL, it will be clubbed to the amount shown as exempt u/s 10(38) . Right ?
(1) If paid from accumulated profits , the amount has to be treated as Dividend & credited to Dividend Received A/c .
(2) If paid from Capital (Not from accumulated profits) , then it has to be treated as Capital Gain .
Now,Yogesh , is my understanding perfect ?
There is still 1 question( This is in case it is to be treated as Capital gain) :-
The purchase date for all shares is before more than 1 year from receipt of the Rs. 4720 . So it is LTCL (For Shares , "Long Term" is defined as period of more than one year) .And Since LTCG on Shares is exempt from Tax u/s 10 , can Indexation be applied to the Cost ?
Anyway , either way , finally , this amount will be clubbed to the amount that is shown as exempt income u/s 10 in the Income Tax Return . Only difference is , if it is considered as Dividend , it will be clubbed to the amount shown as exempted u/s 10(34/35) & if it is LTCL, it will be clubbed to the amount shown as exempt u/s 10(38) . Right ?
14 June 2014
the provision as explained Mr. Yogesh Goel are very correct but as per the circumstances here they are not reqd here.
As Because if you read Section 2(22)(d) it is explained as follows
Any Distribution to its shareholders by a company ON REDUCTION OF ITS CAPITAL to the extent to which the......
It is very clear that the word REDUCTION is the main view for applying the section here
but considering the situation here NO Reduction is being done in the CAPITAL
only the face value of the shares are split but there is no reduction involved here
& second most important thing here is no distribution involved here
considering all this in my view no section 2(22)(d) is applicable
the section 2 (22) (d) is for plugging the loop hole of the company which reduces the share capital by distributing assets
here no question of reduction is involved as because
for eg
original capital 1000 shares of Rs.10
split Capital 2000 shares of Rs.5
does not change the share capital amount i.e it neither increase nor reduce it.
As Because if you read Section 2(22)(d) it is explained as follows
Any Distribution to its shareholders by a company ON REDUCTION OF ITS CAPITAL to the extent to which the......
It is very clear that the word REDUCTION is the main view for applying the section here
but considering the situation here NO Reduction is being done in the CAPITAL
only the face value of the shares are split but there is no reduction involved here
& second most important thing here is no distribution involved here
considering all this in my view no section 2(22)(d) is applicable
the section 2 (22) (d) is for plugging the loop hole of the company which reduces the share capital by distributing assets
here no question of reduction is involved as because
for eg
original capital 1000 shares of Rs.10
split Capital 2000 shares of Rs.5
does not change the share capital amount i.e it neither increase nor reduce it.
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