Case Study 7 - Income Tax Act 1961 (Gift of Equity Shares)

Question

Mrs. A transferred her shares (procured before 31 January 2018) without any consideration to Mr. A , demat account in 2019-20. Mr. A has sold some of these shares in 2020-21. Please discuss the matter on below mentioned points;

1. How do Mr. A calculate the long-term capital gain or loss?
2. Should it be according to the market value of shares as on 31 January 2018, on the date these were transferred to Mr. A or on the date of procurement by his wife?

Will the gain or loss be booked to Mr. A or his wife?

Answer

Please Note That

As per Section 2(14) of the Income Tax Act, shares and securities are Capital Assets. The transfer of a Capital Asset is taxable as Capital Gains. However, the definition of ‘transfer’ as per Section 47 specifically excludes gifts. Thus, the gift of shares and securities is not taxable in the hands of the sender of the gift.

Taxes on the gifting of shares are exempt in the following situations:

1. Individual receiving gift from a relative (including siblings, spouse and lineal ascendants or descendants);

2. Individual receiving gift on the occasion of marriage;

3. Gift received by way of inheritance.

In case the donee is a relative as per income tax act which includes spouse, siblings of self/spouse, children, linear ascendants and descendants of self/spouse, etc., the gift received is not taxable, irrespective of the value of the shares transferred.

In case the shares are gifted to someone other than relatives as mentioned in the Income Tax Act, the same is tax-exempt if the value is less than Rs 50,000. For the valuation of the shares, FMV is to be considered. However in case, the FMV of the shares gifted is more than Rs 50, 000, the transfer gets taxed in the hands of the receiver under the head income from other sources.[ Section 56(2) of IT Act,1961]

INCOME EARNED ON GIFTED SHARES

In case of income arising from shares gifted to a spouse or minor child, provisions of clubbing of income shall apply.

If the receiver of the gifted asset is a spouse or minor child, any income that arises directly or indirectly from such asset is clubbed with the income of the donor as per Section 64(1)(iv) & Section 64(1A) of the Income Tax Act.

However, in the case of an adult child, the same stands taxable in the hands of the donee and not the doner.

LET'S FOCUS ON QUESTION

The transfer of shares by Mrs. A to Mr. A , for no consideration, will not attract any capital gains in her hands. However, any income, including capital gains, accruing to Mr. A from such shares, shall be clubbed in the hands of his wife, i.e. Mrs. A .

The shares gifted (assuming listed equity shares) were held for more than 12 months (combined period of holding considered for Mr. A and his wife) and therefore, would be classified as a long-term capital asset.

Upon transfer of these shares, the long-term capital (LTCG) - Sales Price less Cost of acquisition— exceeding Rs 1 lakh would attract tax at 10%, in the hands of your Mrs. A .

SECTION 112A PROVIDES for long term capital gains on the sale of listed equity shares, equity-oriented mutual funds, and the units of a business trust. The said section was introduced in Budget 2018 after the removal of exemption under section 10(38). It is applicable from the financial year 2018-19. It provides for taxation of long-term capital gains on listed securities at 10% for gains exceeding the threshold limit of Rs. 1 lakh.

SCOPE OF SECTION 112A

The following conditions apply for availing the benefit of the concessional rate under section 112A of Income Tax Act.

1. In the case of an equity share of a company, the securities transaction tax(STT) has been paid on the acquisition and transfer of such assets.

2. In the case of the units of an equity-oriented fund or the units of a business trust, the STT has been paid at the time of sale of the asset.

3. The securities should be long-term capital assets.

4. Deduction under chapter VI A cannot be availed in respect of such long-term capital gain.

5. Rebate under section 87A cannot be claimed in respect of tax payable on long-term capital gain under section 112A

In the case of long-term capital loss arising out of such sale, the entire amount shall be allowed to be carried forward in subsequent years. However, Mrs. A needs to file the return of income on or before the due date.

CALCULATION OF COST OF ACQUISITION OF SHARES

1. The shares were purchased by Mrs. A before 31 January 2018; thus, the cost of acquisition (CoA) upon transfer by you, shall be determined as follows:

If the net sale proceeds (after transfer expenses like brokerage, commission, etc.) from the sale of shares (hereinafter referred as NSP) is more than the fair market value (FMV) of such shares on 31 January 2018, then Cost of Acquisition is higher of:

a) The actual cost to Mrs. A;
b) FMV as on 31 January 2018.

2. If the NSP(Net Sale Proceeds) is more than the FMV(Fair Market value) of shares as on 31 January 2018, then the Cost of Acquisition will be higher of:

a) The actual cost to Mrs. A;
b) The Net Sale Proceeds (NPS)

Thus, the LTCG, arising in Mr. A hands, to be clubbed to Mrs. An income will be Net Sale Proceeds minus the Cost of Acquisition (as determined above).

Further, if the sale proceeds from this transfer are invested elsewhere, then any income arising from such investment in Mr. A hands, shall also be clubbed in the hands of his wife and included in her total income.

LET’S CONSIDER AN EXAMPLES

Mrs. A purchased 5000 shares at INR 100 of ABC Ltd on 1^st April, 2021. She has gifted 2000 shares to Mr. A (husband), on 1st September 2021. FMV on 01/09/2021 was INR300 per share. Mr. A sold out these shares on 2nd March 2022 at INR 500. Calculate the tax liability.

1. Tax treatment for Mrs. A (donor) - No tax liability since the gift of shares is not treated as a transfer of capital asset between relatives.

2. Tax treatment for Mr. A (donee or received of the gift);

• On receiving a gift - no tax liability since gift from a relative is an exempt income as per Section 56(2)(vii) of Income Tax Act.
• On the sale of shares. Here is the tax calculation:

o Sale Date - 02/03/2022
o Sale Value - INR 10,00,000 (500 * 2000)
o Purchase Date - 01/04/2021 (as per previous owner)
o Purchase Value - INR 1,00,000 (100 * 1000) (as per previous owner)
o LTCG =10,00,000 - 1,00,000 = INR 9,00,000
o Tax on LTCG u/s 112A = 10% * (9,00,000-1,00,000) = INR 80,000

TAX TREATMENT

The donor ( Mrs. A ) of the gift need not report the gift in the Income Tax Return. The receiver of the gift( Mr. A ) should report the gift under Schedule Exempt Income if the income is exempt or Schedule OS (IFOS) if the income is taxable. If the gift is taxable, calculate tax liability at slab rates.

Disclaimer: the case law presented here is only for sharing information with the readers. The views are personal . In case of necessity do consult with tax professionals.