Tejas P Shah – [2025] 176 taxmann.com 618 (Article)
In computing capital gains and the tax on the sale of shares, it is critical to determine the cost and the period of holding of such shares, where the cost is the price paid to acquire the shares and the period of holding refers to the time for which such shares have been held.
The holding period influences several other aspects of capital gains taxation, such as the tax rate, eligibility for claiming indexation benefit and the manner of carrying forward and adjusting losses, if any.
Section 2(42A) of the Income-tax Act, 1961 (IT Act) is a detailed provision which defines short-term capital assets. Per this section, an unlisted share held for 24 months or less or a listed share held for 12 months or less falls under the category of a short-term capital asset. Further, Section 2(29AA) of the IT Act defines a long-term capital asset as something that is not a short-term capital asset. Accordingly, an unlisted share held for more than 24 months, or a listed share held for more than 12 months, shall be regarded as a long-term capital asset.
Section 2(42A) of the IT Act provides general guidance on whether shares qualify as short-term or long-term capital assets based on the holding period, typically in a standard share acquisition scenario. However, explanation 1 to Section 2(42A) elaborates on how to calculate the holding period in case of various additional scenarios, such as the issue of shares pursuant to mergers, demergers, conversion of debenture or preference shares and bonus shares issued.
Notably, Section 2(42A) of the IT Act does not provide specific guidance on determining the holding period for shares issued pursuant to sub-division/split. Section 55(2)(b)(v)(d) of the IT Act mentions the cost of acquisition to be considered for split/subdivided shares. This differentiation, i.e., specific mention of the cost of acquisition and not the period of holding of split/subdivided shares, has been causing an anomaly in the determination of the period of split/subdivided shares.
Companies preparing for an IPO often expand their share capital base (i.e., number of shares) by using bonus shares or conducting share splits before going public. For a company with a limited number of shares, the price per share may be high, which may, in turn, limit the interest of retail investors in subscribing to the shares. By increasing the share capital base, companies ensure that their shares become more affordable and accessible to investors, ensuring higher market participation and interest.
Also, in view of the importance of the commonality of share splits undertaken prior to an IPO, we have attempted to analyse how to determine the holding period for shares issued pursuant to sub-division/split of original shares, relying on judicial precedents and technical interpretations.
Imagine a scenario where a company has 10,000 outstanding equity shares with a face value of INR 10 each, acquired initially by shareholders in January 2020. The company has now decided to split each of these shares into five shares of face value INR 2 each (i.e., divided in the ratio of 5:1) in January 2024. This shall lead to the company’s outstanding share count increasing to 50,000 equity shares of face value INR 2 each after the stock split. The company plans an IPO in January 2025, wherein shareholders would sell a certain portion of their shares (issued pursuant to a split) under the Offer for Sale (OFS) mechanism.
In the instant case, when shareholders transfer their certain portion of split/subdivided shares in OFS in January 2025, a question arises whether period of holding on such shares should be calculated from the original date of investment (i.e., January 2020) or date on which split shares were issued (i.e., January 2024). It should be noted that since the shares would remain unlisted pursuant to offloading/transfer in the OFS, the shares shall be regarded as short-term capital assets if they are held for 24 months or less.
If the period of holding for split shares is considered from January 2024 (the date of split/sub-division) and not from January 2020 (the date of original acquisition of shares), gains would be termed as short-term capital gains, liable for applicable short-term capital gains tax. If the period of holding for split shares is considered from the date of acquisition of original shares, then the gains would be termed as long-term capital gains, liable for the applicable long-term capital gains tax.
The definition of short-term capital asset in Section 2(42A) of the IT Act specifies that an assessee must hold unlisted shares for not more than 24 months immediately preceding the date of their transfer for it to be regarded as a short-term capital asset. This implies that the shares must be held as identifiable capital assets during the 24-month period required under this section.
As there is no other guidance available on determining the period of holding in the case of split shares, it may be possible to consider that split shares are distinct and identifiable capital assets that come into existence only upon their issue (i.e., in January 2024). In the instant case, if the shareholders do not hold them for more than 24 months, they may regard them as short-term capital assets.
Without prejudice to the above, sub-clause (f) of clause (i) of explanation 1 of Section 2(42A) of the IT Act stipulates that the holding period for financial assets (such as shares) allotted without any consideration and based on the holding of another financial asset, would commence from the date of such actual allotment. While this provision is typically applied to determine the holding period of bonus shares (which are issued without consideration and based on existing holdings in the company), one might argue that even split shares are covered under this provision as they are also issued without consideration and against the holding of original shares in the company. Accordingly, in the instant case also, it may be said that the holding period of split shares also begins from the date of their allotment, i.e., January 2024.
Clause (ii) of explanation 1 of Section 2(42A) of the IT Act states that if the period of holding with respect to a particular capital asset has not been prescribed under Section 2(42A) of the IT Act, then the period shall be determined in accordance with rule 8AA of the Income Tax Rules, 1962. The Central Board of Direct Taxes has notified a few of the cases (i.e., period of holding of shares derived pursuant to conversion of debentures/bonds, etc.), but has not specifically clarified the determination of the period of holding for split/subdivided shares to date.
Per Section 55(2)(b)(v)(d) of the IT Act, the cost of acquisition for the purpose of calculating capital gains in case of sub-division of shares would be calculated with reference to the cost of acquisition of the original shares from which such sub-divided shares are derived. Accordingly, subdivided shares are treated as the same capital asset as the original shares for income tax purposes. Therefore, it may be possible to argue that where cost can be referred to original shares, period of holding can also be referred to the original shares.
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