Bonus shares — a company’s way of remunerating stockholders in kind — are a subject of heated debate between taxmen and corporations, the latter backed by regulators.

The question is: should bonus issues be taxed? And if taxation is inevitable, how should it be imposed?

Bonus shares are additional shares given to existing shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are a company’s accumulated retained earnings, which are not given out in the form of cash dividends but are converted into free shares.

Bonus shares are given when companies are short on cash or wish to retain funds for planned or future expansion and diversification, but still have to satisfy shareholders who expect a fair return on investment.

The question is: should bonus issues be taxed? And if taxation is inevitable, how should it be imposed?

Opposed to ‘right shares’ which have to be paid by shareholders, bonus shares are issued by companies for free. They are, therefore, delightful for shareholders, as bonus issues tend to increase the number of shares held by them in the issuing company.

“But if you give it a hard look, such jubilation is just skin-deep”, says a veteran stockbroker. He points out that after the issue of bonus shares, the number of a company’s outstanding shares increases which impacts its cash dividend capacity. Bonus shares also tend to increase ‘free-float’ which dilutes the market price of the stock as well as its break-up value on the balance sheet.

But most shareholders rarely look beyond their own holdings. Bonus shares were tax-free until three years ago. Then came the levy. The tax department noted that companies had issued bonus shares to the value of Rs150bn. Calculations showed a mouth-watering sum of Rs7.5bn that the FBR thought it could collect in the form of tax on this account. But that was not to be.

The Finance Act, 2014 decreed that bonus shares could only be issued to a shareholder if a company, quoted on the stock exchange, collected tax at 5pc of the value of bonus shares issued to the shareholder including bonus shares withheld, determined on the basis of ‘day-end price’ of the first day of closure of books.

That came as a bolt from the blue for listed companies and they began to put brakes on bonus issues. Beleaguered shareholders who thought they were robbed of a healthy return have continued to demand abolition of the tax. The Pakistan Stock Exchange (PSX) has tried to make things simpler. At the top of its nine-point budget proposals for 2017-18, the bourse has placed: ‘Rationalisation of Tax on Bonus Shares’.

The PSX argues that the levy has done no good. Only a year before the imposition of tax on bonus shares as many as 71 listed corporations had distributed bonus shares of the value of Rs19bn in year July 2013-June 2014.

In the subsequent years the number of companies issuing these shares plunged: In July-June 2014-15, companies issuing bonus shares shrank to just 17 of the total value of an insignificant Rs3.4bn. A year later in July-June 2015-16, a limited number of 20 companies issued bonus shares of Rs3.2bn and the amount has eroded further to Rs1bn worth bonus issues by 12 companies during the first six months of the current financial year.

Following the levy, the government managed to collect a meagre sum of Rs284m in FY2014-15; Rs589m in FY2015-16 and Rs472m in FY2017 (up to February).

The PSX contends: “There is an impression that due to tax on bonus, companies distribute more cash dividend. But numbers show that the distribution of cash dividend as percentage of profit after tax has not changed pre and post bonus tax period”.

A fund manager who was sore on tax on dividend, terming it a ‘double taxation’ affirmed that ‘bonus shares’ were in effect nothing more than an ‘accounting entry’ on a company’s books and that it was cruel to tax shareholders who were already groaning under the burden of too many direct and indirect taxes.

The PSX demands that the current rate of withholding tax be rationalised on the ‘face value’ (instead of market price) of bonus shares as it is estimated that the change to income tax law would result in issuance of bonus shares of face value of at least Rs50bn per year; and result in revenue generation of Rs2.5bn in tax as against Rs0.5bn collected on average in the last three years.

Ancillary advantages of rationalisation have been counted as increase in trading volume, which would generate additional revenues under the head of ‘tax on brokers’ activity; capital gain tax on disposal of securities and capital value tax.

Published in Dawn, The Business and Finance Weekly, May 8th, 2017