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Now, if the rationale, intention and equitability have to prevail, the following will be the answer: the tax super tax levied by the Finance Act, 2022 will be applicable for tax year 2023 and increased or enhanced rate of 10 percent from 4% will be levied from Tax year 2024.

In this connection it is important to note that these principles have been correctly applied in the case of banks which have December 31 as the year-end by making such an increase applicable for the Tax Year 2022. It is concluded that the Lahore High Court’s decision is fundamentally wrong and has not appreciated the matter in proper context.

Tax on Bonus Shares

The Finance Act 2023 has brought in an anti-business idea by taxing bonus shares issued by the companies, public or private, in the hands of shareholders. In the author’s view, the issue of bonus shares cannot be an income in the hands of the shareholder even if it is deemed so in the Ordinance on the basis of wider ambit of ‘income’ as used in the Constitution. Nevertheless, this is not the subject under discussion in this article.

Super tax and tax on bonus: misinterpretation of basic accounting—I

This article deals with another absurdity being the taxability of an existing unrealised/notional wealth by charging tax on bonus shares at the market price. This amply illustrates the fact that the lawmakers have not taken into account full facts or they have improper understanding of the subject. It was only for this reason that this absurd law, which remained in force from 2014 to 2018, could not get implemented.

As per our information, there was complete stalemate on the issue of bonus shares and whenever such shares were issued the demand raised by the department was stayed.

In one of the cases, Sindh High Court incorrectly held the validity of tax on issue of bonus shares. This is a tax that greatly disturbs the corporate business environment. The absurdity of the matter is explained in the following paragraphs.

Market value of listed shares depends, inter alia, on the existing reserves and future profitability of the company. This means that the market value of any share held by a shareholder is the wealth if the shareholder has not realised.

The difference between the cost of such shares and their market value is an income but that remains unrealised until the same is realised in the form of capital gains. If the market value is taxed in any manner then it is effectively the taxation of wealth not of income. The wealth under the Constitution can only be taxed under Entry 50 of the Fourth Schedule to the Constitution not as ‘income’.

Even that portion of wealth, which is the difference between the face value and the market value, is not taxable as Entry 50 only gives the right to tax the cost/value of assets even under the wealth tax or any kind of tax on assets.

When bonus shares are issued there is effectively no change in that wealth. Only the number of shares is increased while value per share decreases. Thus naturally, the market value of the individual share decreases but the aggregate value effectively remains the same.

The present law which is the replica of the law introduced in 2014 is absurd and legally not tenable. Under this process every company, quoted on stock exchange, issuing bonus shares to the shareholders of the company, shall withhold 10 percent of the bonus shares to be issued. This is withholding in kind, not in cash.

Afterwards, there are two options with the shareholder. Firstly, he can get his 10% shares by making a payment to the company as a tax equal to the market value of shares. If the shareholder does not take the ownership of shares by making payment then the company shall dispose of the shares in the market and deposit the proceeds as tax paid by the shareholder.

The question is whether or not the government can collect tax equal to the market price of the shares when (a) price is notional not realised and (b) an asset which existed before that declaration. This absurdity is explained with an illustration as under:

  1. ShareCapital 100

  2. Reserves 100

  3. Number of Shares 10

  4. Face Value Rs 10

  5. Market Price Rs 30.

A company decides to issue bonus shares for each share held by the shareholder. In this situation, the expected price after the bonus share will be Rs 15 as, on account of this reason, the number of shares is doubled and there is no other change. In this case, under the present law, the government is withholding shareholder’s 1 share being 10 percent of the total shares issued. If the shareholder wants to get those shares then he is asked to pay Rs 15, which is the price of 1 share after the bonus share.

The question is whether or not the government can make the shareholder poorer by Rs 15 on account of tax on bonus shares as before the issuance of bonus shares the value was Rs 300 (30x10), which will become 285 as the shareholder has paid tax of Rs 15 as tax. This equation can be well understood if we consider that the shareholder does not pay the tax and the company sells the bonus shares in the market.

In this case the position will emerge as 10+9=19 X 15=285. This raises the primary question whether or not it is a wealth tax under Entry 50 or taxes on income. In no situation can it be treated as taxes on income at least to the extent of Rs 5 out of Rs 15 for the reason that these were the reserves, which will invariably be available to the shareholders.

In the past for this primary and fundamental difference, ‘face value of bonus shares’ was taken as income, though wrongly, on the premise that reserves which existed in the financial statements are the ownership of the shareholders; therefore, these can be treated (whether or not distributed) as income of the shareholder.

To conclude, it is obvious that the market value basis of taxation is fundamentally wrong. Those who have made law are not fully aware of this mechanism and they have some misperception about unrealized income. No law in this manner exists anywhere in the world.

Notwithstanding these technical aspects, it is a simple view of the author that the tax law in Pakistan, which is contained by way of Income Tax Ordinance, 2001, can only tax the realised or actual income. There is no point in taxing notional and unrealized incomes in the hands of shareholders.

It is also to be noted that in the books of the company issuing bonus shares, irrespective of the market price reserves, will be debited with the amount equal to the face value of bonus shares. Thus a shareholder cannot be burdened more than what has been effectively capitalised by the company.

It is important to note that if that system is applied then the government will only receive only 10% tax on dis posal of bonus shares. On the other hand, if there is an actual disposal of bonus shares then the gain is taxable at the higher rate of 15%. This desire to tax bonus shares in this manner has not been admired or approved of. It is, therefore, suggested that the whole idea of taxing bonus shares be dropped as it is a fact that during the period from 2014 to 2018 when this tax was payable there was effectively no bonus issue. Even if the idea is carried through, the concept of charging bonus shares at market value in this indirect manner is economically, commercially and legally wrong.

In the case of unlisted companies the manner of taxability is fundamentally contradictory to corporate law. Shares of a private limited company issued as bonus shares cannot be sold like the shares of a listed company. Thus the whole process laid down under Section 236 Z is wrong in a practical sense for a private limited company. This shows that those who have laid down this provision have not taken into account the respective provisions of the corporate law.

It is important to note that in the case of private limited companies the tax department under the law can never acquire the right to hold shares and sell the same in the market. That would be illegal. It is therefore suggested that this provision be stayed from operation for the time being under the power conferred to the Federal Government and if any taxability is to be made then the same should be limited to the face value of bonus shares.


Copyright Business Recorder, 2023


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Tax on bonus shares is an absurdity and anti business .
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