Foundation — Equity income, the charges on a trade, and the section 112A grandfathering

At a wedding in Lucknow, the bride's uncle stands up at the reception, in front of everyone, and announces a gift of Rs 51,000. From that moment it is a public commitment. Whether the envelope reaches her that night or three weeks later makes no difference — the promise was made in front of the assembly, and it binds.

That is a FINAL dividend, declared at the annual general meeting. The workbook: it is deemed to be the income of the previous year of the shareholder IN WHICH IT IS DECLARED. THE DATE OF RECEIPT BY THE ASSESSEE IS NOT MATERIAL.

Now take a different uncle, who says privately to a cousin, "I am thinking of giving her something." Nothing has been announced, nothing binds him, and he may change his mind. Only when the money is actually put into her hand does anything exist.

That is an INTERIM dividend, declared by the board rather than the members and revocable until paid. The workbook: it is deemed to be the income of the previous year IN WHICH THE AMOUNT IS UNCONDITIONALLY MADE AVAILABLE by the company — in other words, it is chargeable to tax ON RECEIPT BASIS.

The distinction is not arbitrary. A final dividend becomes a debt owed on declaration; an interim one does not. The assembly makes the difference.

A cricket club charges a gate fee to enter the ground. The fee is not refundable, it cannot be set against your bar bill, and nobody enjoys paying it. But without the ticket stub you cannot sit in the members' enclosure, where the seats are better and cheaper.

Securities Transaction Tax works exactly like that stub, and the combination is genuinely odd.

You cannot deduct it. Chapter 8 is explicit: no deduction is allowed in respect of any sum paid on account of Securities Transaction Tax (STT), Commodities Transaction Tax (CTT) while calculating the capital gains from sale of securities. Brokerage on the very same contract note is deductible; STT is not.

Yet you need it. Section 112A applies only when securities transaction tax is paid at the time of acquisition AND at the time of transfer, and section 111A's 20 per cent short-term rate depends on STT too. Table 11.1 shows what the stub buys: long-term gains with the first Rs 1.25 lakh untaxed, and short-term gains at 20 per cent instead of slab rates.

So the investor pays a tax he can never recover, in order to access rates he could not otherwise reach. For a 30 per cent taxpayer selling short term, the stub converts 30 per cent into 20 per cent — a bargain many times the size of the STT itself.

A fair price shop in Patna serves people strictly in the order they joined the queue. A man of eighty who arrived at eleven o'clock stands behind a boy of twenty who arrived at nine. Age does not move you up the queue. Arrival time does.

That is FIFO in a demat account, and the workbook's Example 1 is built to catch the person who confuses the two.

Four lots sit in the account. The oldest actual purchase is from 1 May 2001 — but those certificates were dematerialised and credited last, on 15 June 2020. The lot credited first, on 1 June 2020, was actually bought on 25 May 2020, barely a week earlier.

Sell 2,500 shares and the workbook says: the cost of acquisition of the first 2,000 shares shall be calculated from 25-5-2020, whereas the balance 500 shares will be treated as having been acquired on 1 November 2005. The 2001 lot is untouched. It is last in the queue, despite being nineteen years the oldest.

The rule is stated plainly: the basis for determining the movement out of the account is the DATE OF ENTRY INTO THE ACCOUNT.

Two dates, two jobs. The credit date decides who is served. The purchase date then decides what they cost and how long they were held.

The same fair price shop opens a second counter. Now there are two queues, and each is served independently. A man standing in the second queue is not served merely because the first queue has moved.

The workbook says exactly this about demat accounts: where an investor has MORE THAN ONE SECURITY ACCOUNT, FIFO METHOD WILL BE APPLIED ACCOUNT-WISE. This is because where a particular account is debited for sale of securities, THE SECURITIES LYING IN HIS OTHER ACCOUNT CANNOT BE CONSTRUED TO HAVE BEEN SOLD AS THEY CONTINUE TO REMAIN IN THAT ACCOUNT.

And this is one of the few genuine planning tools in the whole chapter.

Within one account the investor has no choice at all — the oldest credit goes first, with its cost and its holding period. But if he had placed his 2019 purchase in Account A and his 2025 purchase in Account B, he could sell from either and the law would respect it.

The catch is that the accounts must be separated at the time of purchase, not at the time of sale. Once both lots sit in one account, the queue is fixed and nothing can reorder it.

That is why an adviser earns his fee before the trade, not after.

A landlord agrees that a long-standing tenant should not be charged for improvements he made before 2018, but also should not be able to claim for damage he did not suffer. So the tenancy agreement gets two locks.

That is the section 112A grandfathering formula, and both locks must be described in any answer.

Lock one — the "LOWER of" step. Take the lower of the 31 January 2018 fair market value and the actual sale price. This stops Scenario 2's mischief: a share bought at Rs 100, valued at Rs 200 on 31 January 2018, and sold at Rs 150. Without the lock, the cost would be Rs 200 against a Rs 150 sale — a Rs 50 "loss" on a transaction that actually made Rs 50 of profit. The workbook is blunt: grandfathering cannot result in a long-term capital gain turning into a long-term capital loss.

Lock two — the "HIGHER of" step. Take the higher of the result and the actual cost. This protects Scenario 3: a share bought at Rs 100 whose 31 January 2018 value had fallen to Rs 50. Without the lock the investor would be taxed on Rs 100 of gain when he really made Rs 50.

And Scenario 4 shows the locks are not a trap: sold at Rs 50 against an actual cost of Rs 100, the loss of Rs 50 is genuine and IS allowed.

Neither lock creates a fiction. Together they ensure the taxpayer is taxed on what he actually made after 31 January 2018, and no more.

A developer in Thane issues allotment letters for shops in a mall not yet built. You pay 25 per cent upfront and have a fixed period to pay the balance and take possession.

Three things can then happen, and each is taxed differently.

You pay the balance and take the shop. Under Regulation 13 of SEBI ICDR the warrant holder pays at least 25 per cent of the strike price upfront, and conversion shall be treated as a TRANSFER of share warrants. The consideration is the fair market value of the shares on the date of conversion under section 50D, and the cost is the strike price.

You sell the allotment letter to someone else. That is a transfer of a capital asset, with the consideration being the sum received from the buyer and the cost being the upfront payment. Note the difference: on conversion you deduct the full strike price; on transfer you deduct only what you actually paid upfront.

You do nothing and the letter lapses. If the option is not exercised within 3 months from the date of payment of full consideration, the money shall be forfeited by the issuer — and here comes the harsh part: the loss arising from such forfeiture will have NO TAX TREATMENT and it will be IGNORED for calculation of taxable income.

Three exits, three answers, and only the third gives you nothing at all.

A grocer runs an offer: buy one packet, get one free. A clever customer buys a packet for Rs 106 the week before the offer, collects his free packet, then immediately sells the first packet for Rs 95 and claims he made a Rs 11 loss.

But look at what he holds. He paid Rs 106, received Rs 95, and still has a free packet in his hand. He has not lost anything — he has simply moved value from the packet he sold into the packet he kept.

Section 94(8) says the same thing in statutory language. Where a person acquires securities within 3 MONTHS BEFORE the record date, is allotted bonus securities, and transfers the original securities within 9 MONTHS AFTER the record date while continuing to hold all or any of the bonus securities, then any loss arising on transfer of the original securities SHALL BE IGNORED.

And the Act does something fair with the ignored amount: the loss so ignored SHALL BE DEEMED TO BE THE COST of purchase or acquisition of the bonus securities.

In the workbook's Example 12 the Rs 11,000 loss is disallowed and the 1,000 bonus shares, which would have had NIL cost, are given a cost of Rs 11,000 — Rs 11 per share.

The loss is not destroyed. It is parked in the free packet, and it comes back when that packet is sold. Note the two different windows: 3 months before, 9 months after.

A household has a monthly ration entitlement of 5 kg of free grain. This month they have drawn only 3.7 kg from the ordinary quota, which has run out. The shopkeeper does not say "bad luck, the quota is finished." He makes up the remaining 1.3 kg from the special stock so that the family gets its full entitlement.

That is the adjustment of the exemption limit against capital gains.

A resident individual or HUF is not chargeable to tax up to the maximum exemption limit. But capital gains taxed at special rates — 112, 112A, 111A — sit outside the ordinary slab structure, so an investor with very little ordinary income might waste part of his basic exemption entirely.

The workbook prevents that: if total income as reduced by the amount of long-term capital gains referred to in section 112 and 112A or short-term capital gains covered under section 111A is LESS than the maximum exemption limit, THE AMOUNT OF SUCH CAPITAL GAINS SHALL BE REDUCED BY THAT AMOUNT that would enable the individual or HUF to FULLY CLAIM THE MAXIMUM EXEMPTION LIMIT.

Its own example: ordinary income Rs 1,85,000, long-term gain on unlisted shares Rs 2,50,000, exemption limit Rs 2,50,000. The shortfall is Rs 65,000, so the gain is reduced by Rs 65,000 and only Rs 1,85,000 of the gain is charged.

Nobody's basic exemption goes to waste merely because their income arrived in the wrong pocket.