Bonus Shares from Trading Stock Taxable as Exempt LTCG: Analysis of ITO Vs Goldflag Holdings Private Limited (ITAT Bangalore)

1. Background and Context

The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT) in ITO Vs Goldflag Holdings Private Limited examined whether bonus shares issued in respect of shares held as stock-in-trade must necessarily be treated as business stock, or whether they can be recognised and taxed as capital assets, depending on the assessee’s intention and accounting treatment.

The Tribunal concluded that:

  • Bonus shares do not automatically assume the character of stock-in-trade merely because the original shares were held as trading stock.
  • Where the assessee consistently treats such bonus shares as investments and holds them for more than 12 months, the resultant gain can be taxed as long-term capital gain (LTCG).
  • In the relevant Assessment Year 2017-18, the gains on sale of bonus shares of Infosys Limited were rightly claimed as exempt LTCG, not as business income.

This ruling is significant for assessees engaged in share and commodity trading who also hold certain securities as investments.

2. Essential Facts of the Case

2.1 Business profile and return filing

  • The assessee, Goldflag Holdings Private Limited, was engaged in:
    • Stock trading
    • Commodity trading
    • Related financial activities
  • For Assessment Year 2017-18, the assessee filed its return of income on 23.10.2017, declaring a loss of Rs. 174,10,569/-.
  • The case was picked up for scrutiny assessment under Section 143(3) of the Income Tax Act 1961.

2.2 The core transaction – sale of Infosys bonus shares

  • The assessee reported long-term capital gain of Rs. 3,55,40,675/- arising from the sale of 30,000 bonus shares of Infosys Limited.
  • These bonus shares:
    • Had been allotted in respect of original Infosys shares held earlier as stock-in-trade.
    • Were, however, classified and reflected as non-current investments from the date of allotment.
    • Were held for more than 12 months before being sold.
  • As bonus shares carry nil cost of acquisition under the Income-tax framework, their cost in the balance sheet was shown as zero, though they appeared in the investment schedule as non-current investments.

2.3 Conduct of the assessee

  • Original Infosys shares were:
    • Treated as trading stock.
    • Sold during Financial Year 2014-15.
  • Bonus shares received on such original holdings were:
    • Classified as non-current investments from the date of allotment.
    • Consistently shown under the investment schedule in the financial statements for 31.03.2015 and 31.03.2016.
    • Retained for more than twelve months, indicating investment intent.

3. Assessment Proceedings and AO’s Stand

3.1 AO’s recharacterisation as business income

The Assessing Officer (AO), while framing the assessment order dated 28.12.2019 under Section 143(3), took the following approach:

  • Observed that:
    • The original Infosys shares on which bonus shares were issued were held and shown as stock-in-trade (inventory).
    • The bonus shares were not reflected with any non-current investment value in the balance sheet due to nil cost.
  • Inferred that:
    • Since the original shares were treated as inventory, the bonus shares must inherit the same character.
  • Consequently:
    • Treated the entire sale consideration of Rs. 3,55,40,675/- received on sale of bonus shares as business income.
    • Rejected the assessee’s claim of exempt LTCG on these bonus shares.

The AO’s primary reasoning was that bonus shares are merely an accretion to the existing stock-in-trade and therefore necessarily form part of business stock.

4. Appeal Before CIT(A): Assessee’s Arguments and Relief

4.1 Assessee’s submissions before CIT(A)

On appeal, the assessee placed detailed submissions before the National Faceless Appeal Centre (CIT(A)), including: