Debentures, Debenture Stock and Deposit Certificates—Bonus Shares to Preference Shareholders Under Dividend

Debentures, debenture stock, and deposit certificates are popular investment avenues in India, offering individuals and institutional investors the opportunity to earn a fixed rate of return. However, the taxation aspects of holding these instruments, particularly with respect to the issuance of bonus shares to preference shareholders under dividend, are subject to specific legal provisions under Indian income tax laws.

In this article, we will delve into the legal framework governing debentures, debenture stock, and deposit certificates, and examine the implications of bonus share issuances to preference shareholders under dividend from an income tax perspective.

Under Indian law, the term "debenture" is defined under the Companies Act, 2013. Section 2(30) of the Act defines "debenture" as a "document which either creates or acknowledges a debt, and includes debenture stock, bonds, and any other securities of a company whether constituting a charge on the assets of the company or not." This definition provides a broad overview of the nature of debentures and encompasses various forms of debt instruments issued by companies.

Debenture stock, on the other hand, refers to a "series of debentures of a company, whether constituting a charge on the assets of the company or not" as defined under Section 2(32) of the Companies Act, 2013. Similarly, deposit certificates represent debt obligations issued by non-banking financial companies (NBFCs) and are governed by the Reserve Bank of India (RBI) regulations.

Taxation of Debentures, Debenture Stock, and Deposit Certificates

The income arising from debentures, debenture stock, and deposit certificates is liable to income tax under the Indian tax laws. The interest income received by debenture holders is treated as "income from other sources" and taxed at the applicable slab rates. Additionally, individuals and entities holding these instruments are required to report the interest income in their income tax returns and pay tax accordingly.

In the case of deposit certificates issued by NBFCs, the interest income is also subject to tax, and the TDS provisions apply to ensure the deduction of tax at source. Furthermore, the interest income earned by non-resident holders of debentures, debenture stock, and deposit certificates is subject to withholding tax as per the provisions of the Income Tax Act, 1961.

Bonus Shares to Preference Shareholders Under Dividend

The issuance of bonus shares is a common practice among companies to reward their shareholders. When a company declares a dividend, it may choose to distribute bonus shares to its shareholders instead of cash dividends. In the context of preference shareholders, the receipt of bonus shares raises specific tax considerations under Indian income tax laws.

Under Section 55 of the Companies Act, 2013, the articles of association of a company may provide for the issue of bonus shares to preference shareholders. However, the issuance of bonus shares to preference shareholders must comply with the terms of the preference share agreements and the Companies Act. Additionally, the Income Tax Act, 1961 contains provisions that govern the tax treatment of bonus shares received by preference shareholders.

Tax Implications

The receipt of bonus shares by preference shareholders is treated as a "bonus element" under the Income Tax Act, 1961. This bonus element is taxed as "income from other sources" at the time of receipt of the bonus shares. The tax is levied at the applicable slab rates, and the preference shareholder is required to report the bonus element in their income tax return.

Furthermore, the bonus element is included in the cost of acquisition of the preference shares for the purpose of calculating the capital gains tax upon the sale of the shares. This tax treatment ensures that the receipt of bonus shares is subject to taxation, thereby aligning with the principle of income tax applicability on all forms of income.

Conclusion

Debentures, debenture stock, and deposit certificates are financial instruments that offer investors the opportunity to earn a fixed rate of return. However, the taxation aspects related to these instruments, including the issuance of bonus shares to preference shareholders under dividend, are governed by specific legal provisions under Indian income tax laws.

The legal framework provides clarity on the treatment of interest income arising from debentures, debenture stock, and deposit certificates, ensuring compliance with income tax obligations. Additionally, the taxation of bonus shares received by preference shareholders aligns with the principles of equity and fairness in the income tax regime.

It is essential for investors, companies, and financial institutions to understand the legal and tax implications of holding and issuing these instruments to ensure compliance with the applicable laws and regulations. The comprehensive understanding of the legal provisions related to debentures, debenture stock, and deposit certificates, along with the tax implications of bonus share issuances, facilitates informed decision-making and promotes a transparent and compliant financial ecosystem in India.