Chapter 13: Tax Provisions for Special Cases

Table of Contents

Table of Contents

Bonus Shares:

  • Additional shares issued by a company to existing shareholders based on already owned shares.
  • No additional cost is required.
  • Issued to provide an incentive and increase the equity base of the company.

Tax Treatment:

  • Dependent on whether shares are held as stock-in-trade or as a capital asset.
  • If held as a capital asset, any profit or gain arising from transfer is taxable as capital gains.
  • If held as stock-in-trade, gain or loss arising is taxable under the head profits and gains from business and profession.

Taxation Under the Head Capital Gains:

  • Gains calculated only at the time of transfer of shares.
  • If bonus shares held as a capital asset, profit from transfer is taxable under the head capital gains.
  • Period of holding determines classification as long-term or short-term capital asset.
  • Cost of acquisition is nil if bonus shares are allotted without payment based on original shares.
  • Sale consideration is the amount received or receivable from transfer.
  • Short-term capital gains taxed at 15% if STT is paid, otherwise added to taxable income.
  • Long-term capital gains taxed at 10% if STT is paid, otherwise 10% or 20% under section 112.

Taxable Under the Head Profits and Gains from Business or Profession (PGBP):

  • Bonus shares held as stock in trade are taxable under PGBP.
  • Shares recorded in books at cost of acquisition.
  • Gains or losses calculated based on sale consideration, cost of acquisition, and expenditure relating to the sale.
  • Assessable under head ‘Profits and gains from business or profession’ at applicable tax rates.

Taxation on Share Split or Consolidation of Shares

Topic Notes
Taxation on Share Split or Consolidation of Shares – Stock split: dividing outstanding shares into smaller shares.
– Consolidation of shares: merging shares to decrease the number of shares and increase market value per share.
– No tax on splitting or consolidation, but tax on sale of converted shares.
Cost of acquisition of shares after consolidation Total amount paid for original shares apportioned between consolidated shares.
Example of cost of acquisition after consolidation Mr A had 2,000 shares of XYZ Ltd. at Rs. 100 each. The company consolidated 2 shares into 1 share of Rs. 200 each. After consolidation, Mr A had 1,000 shares of Rs. 200 each. Cost of acquisition of consolidated shares = Rs. 200 per share.
Cost of acquisition of shares after split Amount paid for original shares divided proportionately to split shares.
Example of cost of acquisition after split Mr A purchased 1,000 shares of XYZ Ltd. at Rs. 150 each with face value of Rs. 100. The company split one share into two shares of Rs. 50 each. After split, Mr A had 2,000 shares of Rs. 50 each. Cost of acquisition of split shares = Rs. 75 per share.
Period of holding Calculated from acquisition of original shares.
Taxation under the head PGBP Gains calculated only at sale/transfer of split up or consolidated shares held as stock in trade.
– ICDS-VIII (Securities) records such shares at cost of acquisition.
Example of business income calculation Mr Rishabh bought 10,000 shares of a company at Rs. 400 each, held as stock in trade. The company split shares into two of Rs. 50 each. He sold 20,000 shares at Rs. 207 each.
Business income = Rs. 140,000 [(20,000 shares * (Rs. 207 – Rs. 200)].

Taxation of Buyback of Shares-

Table:

Topic Taxation of Buyback of Shares
Meaning of buy-back Purchase of a company’s own shares in accordance with the law
Domestic company liability Liable to pay tax on distributed income under section 115QA
Shareholder exemption Consideration received by shareholders is exempt under section 10(34A)
Capital gains tax Shareholders of foreign companies pay capital gains tax under Section 46A
Changes in provisions Finance (No. 2) Act, 2019 extended provisions to listed and unlisted shares
Distribution tax rate Domestic company tax rate is 20% + 12% surcharge + 4% cess
Payment of tax Tax must be paid within 14 days through challan No. ITNS 280
Consequences of default Interest at 1% per month for late payment, deemed assessee-in-default

Example: Mr. X subscribed to 10,000 shares of ABC Ltd at Rs. 100 per share, and the company announced a buyback at Rs. 125 per share. The liability in the hands of the company and Mr. X are:

  • Mr. X: No income is assessable as the income arising due to buyback of shares is exempt under section 10(34A).
  • ABC Ltd: Liable to pay tax on distributed income under section 115QA at a rate of 20% + 12% surcharge + 4% cess. The tax must be paid within 14 days through challan No. ITNS 280. Failure to pay within the specified time will result in interest at 1% per month and being deemed as an assessee-in-default.

Taxation of Companies in Liquidation-

Heading Detailed Description
Taxation of Companies in Liquidation Liquidation or winding up refers to the process of ending the business of a company, which involves selling the assets of the company. The taxation of companies in liquidation can be understood by considering the tax liabilities in the hands of the company and the shareholders, the computation of capital gains, and an example illustrating the taxability in the hands of the company and the shareholder.
Meaning of Liquidation Liquidation or winding up refers to the process of ending the business of a company, which involves selling the assets of the company. The term dissolution means official extinction of the corporate person.
Tax Liability in the hands of the Company If the liquidator sells the assets and distributes the cash so realized to the shareholders, the company shall be liable to tax on the capital gains arising from the sale of the assets. However, if the assets are distributed to the shareholders on liquidation, no capital gains arise in the hands of the company.
Tax Liability in the hands of the Shareholders Any distribution made to the shareholders on liquidation, to the extent it is attributable to the accumulated profits of the company, is treated as deemed dividend taxable under the head income from other sources. Any amount distributed over and above the amount treated as dividend is taxable as capital gains in the hands of shareholder. The capital gains shall be liable to tax in the year which assets are distributed to the shareholders.
Computation of Capital Gains The capital gains accruing to a shareholder from the distribution of assets by a company in liquidation are determined by deducting the amount treated as deemed dividend, cost of acquisition/indexed cost of acquisition of shares, and expenditure in connection with transfer from the sales consideration (market value of asset on the date of distribution).

Taxation of Right Issues-

Topic Description
Meaning of Right Issue A way of raising additional capital by giving existing shareholders the right to subscribe to newly issued shares in proportion to their existing holdings at a price lower than the market price.
Taxability at the time of renunciation of right Capital gains will arise in the hands of the shareholder who renounces his right in favour of any other person. Any right available to a shareholder to subscribe to shares is treated as ‘capital asset’ under Income-tax Act.
Cost of acquisition The cost of acquisition of the rights so renounced shall be nil.
Period of holding The period of holding of such capital asset shall be reckoned from the date of offer made by the company to the date of renouncement. Such right is deemed as ‘short-term’ if it is held for not more than 36 months preceding the date of its transfer.
Sale consideration The sale consideration shall be the amount received or receivable by the person renouncing the right.
Computation of capital gains Sale consideration minus cost of acquisition and expenditure in connection with transfer will give you the short-term capital gains.
Applicable tax rates Short term capital gains are chargeable to tax as per the tax rate applicable according to the status of the assessee.

Taxation in case of Mergers & Acquisitions

Aspects of Taxation Explanation
Meaning of Merger – Merger is the voluntary fusion of two companies either by closing the existing companies and making a new one or by one company absorbing the other company.
– Amalgamation is defined as the merger of one or more companies with another company or the merger of two or more companies to form one company.
Taxability at the time of allocation of shares – No tax implication in the hands of the shareholder at the time of allotment of shares of the amalgamated company in lieu of shares held as capital asset in the amalgamating company.
– Transfer is not regarded as transfer as per Sec 47(vii) provided the amalgamated company is an Indian company.
Taxability at the time of transfer of shares – If the shares acquired in the amalgamated co. are held as capital asset, the profits from its transfer shall be taxable under the head capital gains.
– If such shares are held as stock-in-trade, the profit or losses arising from the transfer shall be taxable under the head profits and gains from business or profession.
Shares held as capital assets – The capital gains from transfer of shares acquired in the amalgamated company shall be computed as per general provisions.
– The cost of acquisition of the shares acquired in the amalgamated company shall be the amount paid by the shareholder at the time of acquisition of original shares of the amalgamating company.
– The period of holding is reckoned from the date of acquisition of original shares in the amalgamating company.
Shares held as stock-in-trade – The gains or loss from transfer of shares acquired in the amalgamated company shall be computed as per general provisions.

Taxation in case of Stock Lending and Borrowing

Topic Description
Meaning of Stock Lending SLB is a system wherein a person can lend his securities to a borrower through approved intermediary for a specified period. It is a temporary lending of securities executed by a lender to a borrower, for a stipulated duration, for a certain fee.
Regulatory framework SEBI regulates the lending and borrowing of securities through Securities Lending Scheme, 1997. All market participants in the Indian securities market are permitted to lend and borrow securities through an Authorized Intermediary (AI).
Process of lending and borrowing Lender and borrowers place an order with intermediary mentioning the stock, quantity to lend or borrow, time period, and lending fees. The borrower is required to deposit 100% of the lending price and lending fees on an upfront basis.
Benefits of SLB Lender can earn incremental return on an idle portfolio. Borrower can borrow securities to cover short-positions, avoid settlement failure or for arbitrage or hedging strategies.
Taxability in hands of lenders The fee earned from lending business shall be taxable under the head ‘profits and gains from business or profession’ or ‘Income from other sources’.
Taxability in hands of borrowers Any gains or losses arising to the borrower from the sale of such shares shall be taxable under the head capital gains or PGBP, as the case may be. The fee paid by the borrowers may be claimed as deduction while computing the income under capital gains or PGBP.

Taxation in case of conversion of Preference Shares into Equity Shares

Particulars Implications
Definition of ‘Transfer’ Section 2(47) of the Income-tax Act includes exchange of assets within the definition of ‘transfer’. Any conversion of an asset into other asset is also an ‘exchange’ and is treated as transfer, thereby attracting capital gains tax.
Exclusion from the scope of ‘Transfer’ Section 47 of the Act specifically excludes certain types of transfer from the scope and meaning of the word ‘transfer’ in relation to a capital asset. The transaction of conversion of preference shares into equity shares has been excluded from the scope of transfer.
Tax Implications of Conversion As per Section 47(xb) of the Income-tax Act, conversion of preference shares of a company into equity shares of that company is not treated as transfer. Thus, no capital gain shall arise on conversion of preference shares into equity shares.
Cost of Acquisition and Holding Period When a person subsequently sells equity shares, the cost of acquisition thereof shall be the same as that of the preference share. Further, the period of holding of equity shares shall be reckoned from the date of acquisition of the preference shares.
Calculation of Capital Gain on Transfer The capital gain arising on transfer of equity shares shall be computed in the financial year in which the transfer takes place. For example, in the given case, the capital gain shall be computed in the financial year 2020-21. Long-term capital gain tax in excess of Rs. 100,000 shall be charged at the rate of 10% under Section 112A of the Income-tax Act.

Taxation in case of Conversion of Stock into Capital Asset

Topic Notes
Taxation in case of Conversion of Stock into Capital Asset Inventory of a business converted into or treated as a capital asset, FMV of inventory on date of conversion shall be taxable under ‘profit and gains from business or profession’
Valuation of FMV of stock on date of conversion If shares/securities held as stock-in-trade are converted into capital asset, FMV is determined as per Rule 11UAB of Income Tax Rules, 1962
Determination of cost of acquisition of converted asset FMV of stock on date of conversion taken into consideration for determining business income is considered as cost of acquisition of converted capital asset
Period of holding of converted asset Period of holding of converted capital asset is reckoned from the date of conversion or treatment as capital asset

Taxation in case of Segregated Portfolios of Mutual Funds

Creation of Segregated Portfolio Allowed by SEBI for debt and money market instruments Allotment of Units All existing unit holders in the affected scheme as on the day of the credit event shall be allotted equal number of units in the segregated portfolio as held in the main portfolio.

Taxability of Income Similar to normal mutual funds
Period of Holding Inclusion of the period for which the original units were held in the main portfolio in the period of holding of the units acquired in the segregated portfolio Cost of Acquisition Computed by reducing the cost of acquisition of units held in the main portfolio from the cost of acquisition of units in segregated portfolio.

Taxation in case of Consolidation of Mutual Fund schemes or plans

Topic Taxation in case of Consolidation of Mutual Fund schemes or plans
Transfer of Units Any transfer of units held by a unit-holder in the consolidating scheme of a mutual fund in consideration of allotment of units in the consolidated scheme of the mutual fund shall not be treated as transfer
Exemption The exemption is available provided the consolidation is of two or more schemes of equity oriented fund or of two or more schemes of a fund other than equity oriented fund
Period of Holding Where units of a mutual fund become the property of the assessee in the consolidation scheme of a mutual fund, the period for which the units were held under consolidating scheme is also included in the period of holding of units acquired.
  Where units of consolidated plan become the property of the assessee in consolidation of the plans within the scheme of a mutual fund, the period for which the unit or units were held under consolidating plan within the scheme is also included in the period of holding of units acquired.
Cost of Acquisition Where units in a consolidated scheme of mutual fund became the property of the assessee in consideration of any transfer of units, held by him in the consolidating scheme of a mutual fund, the cost of acquisition of such units is deemed to be the cost of acquisition of the units held by him in consolidating scheme of the mutual fund.
  Where units in a consolidated plan of mutual fund became the property of the assessee in consideration of any transfer of units, held by him in the consolidating plan of the same a mutual fund, the cost of acquisition of such units is deemed to be the cost of acquisition of the units held by him in consolidating plan of the mutual fund.

Taxation in case of winding up of Mutual Funds-

Here are the notes on taxation in case of winding up of mutual funds:

Topic Notes
Types of schemes that can be wound up Close-ended schemes are wound up on the expiry of the scheme duration. Other schemes can be wound up on the happening of an event requiring the scheme to be wound up, or with the approval of 75% of unit holders, or as directed by the Board in the interest of unit holders.
Notice for winding up Trustees must give notice of the circumstances leading to the winding up of the scheme to SEBI and in two daily newspapers with circulation in India and a vernacular newspaper at the place where the mutual fund is formed.
Procedure and manner of winding up Trustees call a meeting of unit holders to approve the winding up of the scheme. The trustee or authorized person disposes of the scheme’s assets and uses the proceeds to pay liabilities and expenses before distributing the balance to unit holders in proportion to their respective interest in the scheme’s assets as on the winding up decision date.
Report on winding up The trustee forwards a report on the winding up to SEBI and the unitholders.
Delisting of units Units of a mutual fund scheme are delisted from a recognized stock exchange as per SEBI guidelines.
Taxation The amount received on winding up of mutual funds is treated like normal redemption amount for tax purposes.

Mock Tests-

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Chapter 13: Tax provisions for Special cases - 1

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1. What is the CII for the financial year 2019-20?

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2. Who is not considered a "Person" as defined under the Income Tax Act?

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3. How can borrowers take advantage of SLB when futures of a stock are trading at a discount?

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4. Short term capital loss can be set off against which income?

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5. Who cannot invest in Sovereign Gold Bonds?

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6. What is the purpose of Cost Inflation Index (CII) under the Income-tax Act?

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7. How is the cost of acquisition of units acquired in a consolidation scheme of a mutual fund determined?

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8. What is included in the period of holding for units acquired in a consolidation scheme of a mutual fund?

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9. Which financial year had a CII of 254?

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10. What happens to the proceeds of sale realized during the winding up of a mutual fund scheme?

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11. Commission received from business forms part of income from

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12. How is the taxability of units transferred from the consolidated scheme of a mutual fund determined?

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13. What is the tax implication when inventory of a business is converted into or treated as a capital asset?

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14. How is the capital gain on the transfer of equity shares computed?

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15. Which financial year had a CII of 264?

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16. Which income is exempt in the hands of REIT?

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17. How is the taxability of income arising from the transfer of units in the segregated portfolio of mutual funds determined?

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18. How is the period of holding of the converted capital asset determined in case of conversion from stock-in-trade?

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19. Under what conditions is the exemption available for the transfer of units in the consolidating scheme of a mutual fund?

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20. How is the fee earned from lending securities taxed?

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21. How are units in the segregated portfolio allocated to existing unit holders in the affected scheme?

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22. Which financial year had a CII of 184?

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23. What is the treatment of the amount received on winding up of a mutual fund scheme?

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24. How are the units of a mutual fund scheme delisted from a recognized stock exchange?

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25. What is the CII for the financial year 2014-15?

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26. What is the treatment of transfer of units in the consolidating scheme of a mutual fund in consideration of allotment of units in the consolidated scheme?

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27. Maximum deduction available to a self-employed person for the investment made in NPS is

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28. What are the actions taken by the trustee or asset management company after the publication of the notice of winding up a mutual fund scheme?

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29. What is included in the period of holding of units in a segregated portfolio of mutual funds?

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30. How is the cost of acquisition of units in the segregated portfolio computed?

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31. Which of the following statements is False?

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32. What are the circumstances that may lead to the winding up of a mutual fund scheme?

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33. What is the procedure for winding up a mutual fund scheme?

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34. How is the fair market value of shares or securities determined on the date of conversion from stock-in-trade to a capital asset?

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35. What is the period of holding considered for equity shares acquired through the conversion of preference shares?

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36. What happens if the borrower fails to return the securities in stock lending and borrowing?

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37. What is the tax implication in case of the conversion of preference shares into equity shares of a company?

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38. What does SEBI permit regarding segregated portfolios of debt and money market instruments by Mutual Fund schemes?

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39. What is the CII for the financial year 2003-04?

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40. How are the gains or losses arising to borrowers from the sale of borrowed shares taxed?

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41. What is the CII for the financial year 2012-13?

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42. How is the cost of acquisition of equity shares calculated in case of conversion from preference shares?

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43. Provisions of GAAR are not applicable in which situation?

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44. What is the CII for the financial year 2002-03?

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45. What is considered as the cost of acquisition of the converted capital asset in case of conversion from stock-in-trade?

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46. What is the margin requirement for lenders in stock lending and borrowing?

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47. Unlisted Zero Coupon Bonds shall be considered as long-term capital asset if they are held for

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48. What happens when the SEBI is satisfied with all measures for winding up a mutual fund scheme?

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49. What is the CII for the financial year 2007-08?

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50. Who is not included in the definition of an "Assessee" as defined under the Income Tax Act?

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NISM-Series-X-B: Investment Adviser (Level 2) Certification

Chapter 13: Tax provisions for Special cases - 2

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1. What is the final payment of tax in respect of the income on buy-back of shares?

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2. What is the meaning of liquidation?

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3. How is the cost of acquisition of renounced rights calculated?

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4. What is the tax rate applicable to short-term capital gains on renounced rights?

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5. How is the tax rate determined for short-term capital gains on the sale of right shares?

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6. What is the meaning of a rights issue?

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7. What is the tax rate applicable to short-term capital gains from the transfer of bonus shares?

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8. What is the tax treatment of buy-back of shares by a foreign company?

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9. How is the cost of acquisition of shares calculated after the split of shares?

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10. What is the sale consideration for bonus shares?

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11. What are the consequences of default in payment of tax on distributed income?

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12. How is the tax liability of shareholders determined on the distribution of assets in liquidation?

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13. What is the meaning of consolidation of shares?

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14. Under which head of income are gains from the sale of bonus shares held as stock-in-trade taxable?

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15. What is the applicable tax rate for short-term capital gains from the transfer of listed equity shares?

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16. What is the tax liability of a company on the distribution of assets to shareholders in liquidation?

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17. What is the period of holding for renounced rights?

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18. What is the cost of acquisition for bonus shares allotted without any payment?

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19. How is the period of holding determined for bonus shares?

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20. In case of liquidation of a company, what happens to the assets remaining after payment of all liabilities?

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21. What is the meaning of stock split?

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22. How are short-term capital gains calculated for the transfer of bonus shares?

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23. How are gains or losses from the sale of bonus shares held as stock-in-trade calculated?

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24. How is the tax treatment of bonus shares determined?

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25. How is the cost of acquisition of shares calculated after the consolidation of shares?

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26. What is the taxability at the time of issuance of right shares?

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27. What is the tax rate applicable to long-term capital gains from the transfer of bonus shares?

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28. How are taxes calculated for shares held as stock-in-trade when split or consolidated shares are sold?

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29. How are capital gains calculated on the sale of shares acquired through rights issue?

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30. What are the tax implications for split/consolidated shares under the head of capital gains?

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31. How are profits from the transfer of right shares held as stock-in-trade taxed?

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32. Who is liable to pay tax on the distributed income in the case of a domestic company buying back its shares?

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33. How is the indexed cost of acquisition of shares calculated in the case of liquidation?

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34. How is the period of holding determined for bonus shares?

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35. What is the cost of acquisition for bonus shares?

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36. How are capital gains computed for bonus shares held as capital assets?

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37. How are capital gains calculated for bonus shares held as capital assets?

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38. What are bonus shares?

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39. Which securities are eligible for lending and borrowing under the Securities Lending Scheme?

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40. How is the cost of acquisition determined for bonus shares issued prior to 01-04-2001?

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41. How is the sale consideration calculated for renounced rights?

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42. What is the maximum duration of an SLB contract?

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43. How are capital gains calculated for the transfer of bonus shares held as capital assets?

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44. What is the period of holding for determining the nature of capital asset for right shares?

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45. What is the meaning of buy-back of shares?

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46. How is the taxability determined at the time of renunciation of rights?

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47. What are bonus shares?

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48. Which type of shares were initially liable for tax in the case of buy-back by a domestic company?

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49. How are gains from the sale of bonus shares held as stock-in-trade taxed?

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50. How is the period of holding of shares in a company in liquidation determined for calculating capital gains?

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51. How is the matching of orders done in the lending and borrowing of securities?

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52. Under the head of capital gains, when are taxes levied on the splitting or consolidation of shares?

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53. How is the period of holding calculated for split/consolidated shares for taxation purposes?

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54. What is the rate of tax payable by a domestic company on distributed profit in the case of buy-back of shares?

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55. What is the sale consideration for bonus shares?

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56. Which regulatory body regulates the lending and borrowing of securities through the Securities Lending Scheme?

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57. Meaning of Stock Lending and Borrowing

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