Author: inavatiq

Issue of shares under the Companies Act, 2013 refers to the process by which a company raises capital by allotting shares to existing shareholders, investors, employees, promoters or other eligible persons in accordance with the provisions of the Act. The Act governs various modes of share issuance, including rights issue, preferential allotment, bonus shares, private placement and sweat equity shares, while prescribing conditions relating to approvals, disclosures, valuation, allotment and compliance to ensure transparency and protection of shareholders’ interests.

Table of Contents

1. Rights Issue
2. ‘Preferential Allotment’ in Case of Fresh Issue of Securities
3. Bonus Shares
4. Sweat Equity Shares

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1. Rights Issue

Further shares to members as their right.

As per section 62(1) of Companies Act, 2013 [Corresponding to section 81(1)(a) of the 1956 Act] if the company decides to issue fresh shares, these should be offered to existing shareholders in proportion (as nearly as practicable) to existing persons who are holders of equity shares.

This is termed as ‘rights issue’.

‘Rights Issue’ means offering shares to existing members in proportion to their existing shareholding. The object is, of course, to ensure equitable distribution of shares and the proportion of voting rights is not affected by issue of fresh shares.

Only One Pre-emptive Right is to Be Given – It is now well settled that only one pre-emptive offer is to be made which is otherwise (should be ‘either’) to be accepted or not at all. The existing shareholders are not to be given further pre-emptive rights in respect of those unaccepted shares. Even such first right can be waived or modified – Sangramsinh P Gaekwad v. Shantadevi P Gaekwad AIR 2005 SC 809 = 57 SCL 476 (SC). In this case, it was also held that the offer of rights shares is an ‘invitation to offer’. A right to share would fructify only when an offer made by company is accepted. The offer is a personal right, which is not inheritable [In this case, the word used is ‘allotment’, but actually, it was only an offer].

1.1 When Rights Issue is Not Required

Rights issue is not necessary in following circumstances. [If rights issue is not necessary, offer can be made to others on private placement basis or public issue can be made].

Employees Stock Option – Issue can be made to employees under Employees Stock option Scheme as per prescribed conditions – section 62(1)(b) of Companies Act, 2013.

Exercise of Option Attached to Debenture or Loan – If an option was attached to debentures issued or loans raised by the company to convert such debentures or loans into shares in the company, rights issue is not required. However, the terms of issue of such debentures or loans containing such option should have been approved by a special resolution by the company in general meeting – section 62(3) of Companies Act, 2013.

Special Resolution by Members Not to Make Rights Issue – If shareholders pass a special resolution that shares may be offered to some of the existing shareholders, employees or other persons, rights issue is not necessary. Valuation of shares should be done by a registered valuer, subject to the compliance with the applicable provisions of Chapter III and any other conditions as may be prescribed – section 62(1)(c) of Companies Act, 2013 [The words in italics inserted w.e.f. 9-2-2018]

[Chapter III of Companies Act, 2013 make provisions relating to prospectus and allotment of securities].

Issue of shares to outsiders without special resolution is illegal and void – Westfort Hi-Tech Hospitals v. V S Krishnan (2007) 76 SCL 185 (Ker HC DB) – confirmed in V S Krishnan v. Westfort Hi-Tech Hospital Ltd. (2008) 83 SCL 44 (SC).

If Member Does Not Accept Rights Offer – If a member to whom shares are offered does not subscribe to rights issue within prescribed time, the offer is deemed to have been declined. A member may even prior to the time specified for closure of offer may intimate that he is not accepting the offer. In such case, the shares can be disposed of by the Directors. The terms of such disposal should not be disadvantageous to the shareholders and the company – section 62(1)(iii) of Companies Act, 2013.

Compulsory Conversion of Loan or Debentures by Government – If Government has given some loans or taken some debentures, Government can order that the loan or debentures be converted into shares of the company at a price considered reasonable by Government. In such case, making rights issue is not necessary – section 62(4) of Companies Act, 2013.

Nidhi Companies Need Not Make Rights Issue – Nidhi companies are exempt from provisions relating to making of rights issue – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

1.2 Issue of Shares by Private Company

A private company was not required to make rights offer under the Companies Act, 1956  (That relaxation is not provided under the 2013 Act).

1.3 Letter of Offer in Case of Rights Issue

Issue of prospectus is not required for rights issue of shares or debentures to existing members of debenture holders, even if the applicant has right to renounce the shares under section 62(1)(a)(ii) of Companies Act, 2013 – section 26(2)(a) of Companies Act, 2013 [corresponding to section 56(5)(a) of the 1956 Act].

As per section 62(1)(a) of Companies Act, 2013, company proposing to make a rights issue is required to send a letter of offer to members. Thus, offer of fresh shares to existing members is not treated as a ‘public issue’. Hence, the company is not required to issue ‘Prospectus’.

The offer letter may be dispatched through registered post, speed post or through electronic mode or courier or any other mode having proof of delivery to all existing members at least three days before opening of the issue [section 62(2) of Companies Act, 2013 – The words in italics inserted w.e.f. 9-2-2018]

In case of private company, this period of three days can be reduced if 90% of members give their consent in writing or by electronic means – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

The letter of offer informs the shareholders their right to subscribe to specified number of shares, in proportion to existing holding. The notice must specify the terms and conditions of offer, and right of renunciation, the time within which the offer must be accepted and other prescribed matters.

The time within which the offer should be accepted shall not be less than fifteen days or more than thirty days. If the offer is not accepted within prescribed period, it is presumed to have been declined – section 62(1)(ii) of Companies Act, 2013.

In case of private company, this period of fifteen or thirty days can be reduced if 90% of members give their consent in writing or by electronic means – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Reduction in Time Line for Rights Issue to Even Less Than 15 Days – As per section 62 of Companies Act, 2013, the time period for providing offer letter to the existing shareholders under rights issue process is between 15 days (now 7 days) to 30 days, beyond which the offer is deemed to be declined. This minimum time limit of 15 days can be reduced to lesser days, as may be prescribed – amendment to section 62(1)(a)(c) of Companies Act, 2013 w.e.f. 22-1-2021. [Reduced to 7 days as stated below].

As per rule 12A  of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 11-2-2021, for the purposes of section 62(1)(a)(i) of Companies Act, 2013, the time period within which the offer shall be made for acceptance shall be not less than seven days from the date of offer.

Letter of Offer by Listed Company – If the company is a listed company, letter of offer must contain details as prescribed by SEBI. As per SEBI guidelines, adequate publicity should be given to the rights issue, so that even if a shareholder has not received the letter of offer, he can still apply for shares on plain paper.

1.4 Prospectus Not Required in Rights Offer Even With Right of Renunciation

Section 26(2)(a) of Companies Act, 2013 [Corresponding to section 56(5)(a) of the 1956 Act] clearly states that issue of prospectus is not necessary in rights issue whether with or without right of renouncement.

Section 62(1)(a) of Companies Act, 2013 [Corresponding to section 81 of the 1956 Act] states that company making rights issue should send a letter of offer.

Department has also clarified vide letter No. 8/81/56-PR dated 4-11-1957, that issue of rights share is a ‘domestic concern’ and hence issue or registration of prospectus is not necessary.

Thus, no prospectus is required for ‘rights issue’ to existing members, even if the members have right to renounce the rights to a third person, who may or may not be a member – same view in Vikram Singh Oberoi v. ROC (2020) 158 SCL 248 = 114 taxmann.com 512 (Mad HC), where it was observed that rights issue does not get converted into public issue even if many members had renounced their entitlement in favour of third parties.

1.5 Meaning of ‘Renunciation of Rights Offer’

If a shareholder is not interested in accepting the offer of additional shares, he can renounce the same in favour of any other person, who may not be member of the company.

Giving of such right of renunciation is mandatory, unless the Articles of the company provide otherwise. This right must be specified in letter of offer given to the shareholder. [Section 62(1)(a)(ii) of Companies Act, 2013].

Normally, ‘rights issue’ is at a price lower than the prevalent market price. A shareholder who may be short of funds can renounce his right to specified number of shares, by ‘selling’ his right to subscribe. He can subscribe to part of his rights and renounce (sell) the balance. This is permissible.

However, the right of renunciation is not available in case of private limited company as private company can restrict transfer of shares.

Resolution Can Specify that Renunciation Can Be Only in Favour of Existing Member – In V O John v. Catholic Syrian Bank Ltd. (2009) 90 SCL 351 (Ker HC DB), a special resolution was passed in general meeting that the renunciation can be only in favour of existing members. Such resolution was held as valid.

1.6 Application for Additional Shares in Rights Issue

Sometimes, some shareholders do not subscribe to the ‘rights issue’. They may not even renounce their right to a third person. In such cases, the Board of Directors can dispose of the un-subscribed shares in a manner which they think is most beneficial to the company, if resolution specifically authorises them to do so. They can allot the un-subscribed portion to any other person.

Normal practice followed by good companies is to ask the shareholders to apply for additional shares, over and above the shares allocable to them as a matter of right. The un-subscribed portion is allotted to the members who have applied for additional shares on an equitable basis and balance amount is refunded.

1.7 ‘Fractional Rights’ in Case of Rights Issue of Shares

Sometimes, rights issue may result in fractional rights e.g. assume that existing share capital is Rs. 150 lakhs and the company wants to issue further capital of Rs. 50 lakhs. Thus, each shareholder will be entitled to subscribe to fresh shares equal to 33.33% of his existing holding e.g. a person holding 300 shares will have right to subscribe to 100 fresh shares. However, a shareholder holding 100 shares will be entitled to only 33 shares and not 33.33 as a fractional share cannot be issued. A shareholder holding 50 shares can get right for only 16 and not 16.667 shares.

The offer of further shares should be offered to holders of equity shares, in proportion to the existing paid up capital, as nearly as circumstances admit. Thus, legally, such fractional rights can be ignored. However, this becomes unfair, particularly to small shareholders.

Hence, good and well managed companies usually permit consolidation of such ‘fractional rights’, so that person consolidating such fractional rights can subscribe for full shares. Sometimes, such fractional rights are consolidated and allotted by the company to others. The holders of such fractional rights are paid cash proportionately out of the proceeds. Since company cannot sell or buy its own shares, a person may be nominated by a company who will sell the consolidated shares and remit the sale proceeds proportionately after deducting expenses, to the individual shareholders.

Coupons for Fractional Rights – In case of listed companies, they must issue coupons for fractional certificates, unless company in general meeting decides otherwise or unless stock exchange agrees otherwise. Such coupons can be sold. A person can consolidate such coupons and apply for shares.

1.8 Issue of Rights Shares to Be Kept in Abeyance If Transfer of Shares Not Registered

As per section 59(4) of Companies Act, 2013, a public limited company can refuse to register a transfer if the proposed transfer is against provisions of Law.

As per section 58(1) of Companies Act, 2013, a private company can decline transfer in pursuance of powers under its articles.

Sometimes, there may be stay of Court on such transfer.

The question is what is the legal position if a public company does not transfer shares as the transfer is against any law or if there is stay from Court or a private company refuses proposed transfer as it is against Articles of the company.

Where any instrument of transfer of shares has been delivered to any company for registration and the transfer of such shares has not been registered by the company for any reason, the company shall keep in abeyance in relation to such shares, any offer of rights shares under section 62(1)(a) and any issue of fully paid-up bonus shares in pursuance of first proviso of section 123(5) – section 126(b) of Companies Act, 2013.

1.9 Issue of Rights Shares Under FEMA

FEMA provisions allow Indian companies to freely issue Rights/Bonus shares to existing non-resident shareholders, subject to adherence to sectoral cap, if any. However, such issue of bonus/rights shares has to be in accordance with other laws/statutes like the Companies Act, as applicable, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (in case of listed companies), etc.

The offer on right basis to the persons resident outside India shall be:

(a) in the case of shares of a company listed on a recognised stock exchange in India, at a price as determined by the company

(b) in the case of shares of a company not listed on a recognised stock exchange in India, at a price which is not less than the price at which the offer on right basis is made to resident shareholders – Annexure 4 para 1 of Consolidated FDI Policy Circular dated 7-6-2016.

Regulation 6 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 provides that a person resident outside India may purchase equity or preference shares or convertible debentures offered on right basis by an Indian company, as per specified conditions.

After rights issue, report should be submitted to regional office of RBI in form FC-GPR, where registered office of company is situated, within 30 days [Regulation 6B of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000].

2. ‘Preferential Allotment’ in Case of Fresh Issue of Securities

Preferential Offer means an issue of shares or other securities, by a company to any selected person or group of persons on a preferential basis. It does not include offer through public issue, rights issue, employee stock option scheme, employee stock purchase scheme, sweat equity shares, bonus shares or Global Depository Receipts (GDR) – Explanation to Rule 13(1) of Companies (Share Capital and Debentures) Rules, 2014.

‘Shares or Other Securities’ means equity shares, fully convertible debentures, partly convertible debentures, or any other securities, which would be convertible into equity shares at a later date – Rule 13(1)(ii) of Companies (Share Capital and Debentures) Rules, 2014.

Thus, the provisions do not apply to non-convertible debentures or preference shares.

Generally, preferential allotment is made to promoters, collaborators etc., without making offer to members on pro rata basis.

Special resolution in general meeting authorising Board to make preferential issue instead of a rights issue is required. Valuation of shares has to be done by registered valuers, subject to the compliance with the applicable provisions of Chapter III and any other conditions as may be prescribed – section 62(1)(c) of Companies Act, 2013, words in italics inserted w.e.f. 9-2-2018.

[Chapter III of Companies Act, 2013 make provisions relating to prospectus and allotment of securities].

Preferential Allotment in Case of Listed Company – In case of listed company, the pricing of preferential issue should be made as per SEBI guidelines. In case of unlisted company, pricing of preferential issue can be made as may be decided by Board of Directors. Other provisions and procedures are similar to issue by private placement.

Such increase by preferential allotment should be as per guidelines issued by Government of India, Ministry of Industry dated 10^th April, 1995, RBI guidelines dated 9th April, 1995 and 16th June, 1995 and SEBI guidelines dated 19-1-2000. Guidelines issued by SEBI are applicable to all preferential allotments in listed companies, while guidelines issued by RBI and Central Government are applicable only to foreign investment. Broadly, these guidelines are identical.

2.1 Preferential Allotment in Case of Public Unlisted Company or Private Company

Provisions are made in rule 13 of Companies (Share Capital and Debentures) Rules, 2014. [earlier, these were made in Unlisted Public Companies (Preferential Allotment) Rules, 2003].

These provisions apply to unlisted public company or private company. In case of listed public companies, provisions of SEBI regulations will apply.

The preferential issue shall company with provisions of section 42 of Companies Act, 2013 relating to private placement.

The issue should be authorised by Articles and special resolution. Company is required to make disclosures as specified – rule 13(2) of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 19-7-2016.

If the preferential issue is only to one or more of existing members, following are not applicable:

(a) Section 42 of Companies Act, 2013 relating to private placement will not apply

(b) filing of private placement offer letter in form PAS.4 with ROC is not required – first proviso to rule 13 of Companies (Share Capital and Debentures) Rules, 2014, inserted w.e.f. 18-3-2015.

Since presently provisions relating to registered valuer are not notified, valuation report shall be made by an independent merchant banker registered with SEBI or independent CA in practice having at least 10 years experience.

The price of such shares or securities issued on preferential basis shall not be less than the price determined on basis of valuation report.

The special resolution should be passed after making specified disclosures in the explanatory statement. The special resolution is valid for 12 months from date of passing.

If convertible securities are offered on preferential basis, value shall be determined upfront on basis of valuation report or on basis of valuation report at the time of conversion. The valuation report should not be earlier than 60 days of the date when holder of security becomes entitled to apply for shares, Disclosure should be made at the time of offer of convertible security – rule 13(2)(h) of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 19-7-2016.

Validity Period of Special Resolution –  Special resolution should be acted within 12 months. Thus, if issue is not made within 12 months, fresh special resolution will be required.

Certificate from Auditor/PCS – Statutory auditors/practicing company shall certify that the issue of the instrument is being made in accordance with rules. The certificate shall be placed before the general meeting.

3. Bonus Shares

If a company is profit making, its accumulated profits and free reserves go on increasing. Thus, actual capital employed (i.e. share capital plus accumulated profit plus free reserves) is much higher than the share capital as reflected in the balance sheet. Hence, profits earned appear to be much higher compared to the share capital. Hence, part of accumulated profits and free reserves can be distributed among members as fully paid bonus shares.

A company may issue fully paid-up bonus shares to its members, out of:

(i) its free reserves

(ii) the securities premium account; or

(iii) the capital redemption reserve account [section 63(1) of Companies Act, 2013] – similar provision in Regulation 39(ii)(D) of Model Articles of Association Table F of Companies Act, 2013.

Bonus Shares Out of Securities Premium Account – Fully paid bonus shares can be issued out of securities premium account – section 52(2)(a) and 52(3)(a) of Companies Act, 2013 and Regulation 39(ii)(D) of the Table F of Companies Act, 2013.

Bonus Shares Out of Capital Redemption Reserve Account – If preference shares are redeemed out of profits, a sum equal to nominal amount of the shares to be redeemed are required to be transferred to capital redemption reserve account under section 55(2) of Companies Act, 2013. This capital redemption reserve account can be used to issue fully paid bonus shares to members – section 55(4) of Companies Act, 2013 and Regulation 39(ii)(D) of the Table F of Companies Act, 2013.

The capital redemption reserve arising out of buy back of securities can be utilised to issue fully paid bonus shares – section 69(2) of Companies Act, 2013.

No Bonus Out of Revaluation of Reserves – Bonus shares cannot be issued by capitalising reserves created by the revaluation of assets [proviso to section 63(1) of Companies Act, 2013] As per SEBI guidelines also, a listed company cannot use revaluation reserves to issue bonus shares.

SEBI Guidelines for Listed Companies – SEBI guidelines for issue of bonus shares should be followed by a listed company.

3.1 Conditions for Issue of Bonus Shares by Capitalising Profits or Reserves

Company can capitalise its profits or reserves for purpose of issue of bonus shares, if following conditions are fulfilled [section 63(2) of Companies Act, 2013]:

(a) it is authorised by its articles.

(b) it has, on the recommendation of the Board, been authorised in the general meeting of the company.

(c) Company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it.

(d) it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity and bonus.

(e) the partly paid-up shares, if any outstanding on the date of allotment, are made fully paid-up.

(f) company complies with such conditions as may be prescribed.

The wording of the provision is such that aforesaid conditions are required to be satisfied only if profits or reserves are to be capitalised. It can be argued that these conditions are not required to be satisfied if bonus shares are to be issued out of securities premium account or capital redemption reserve account.

However, really securities premium account or capital redemption reserve account is also ‘reserve’. Hence, these conditions should be satisfied [This is one of the examples in the Act of clumsy drafting].

3.2 Capitalisation of Profits

Capitalisation of profits is permitted under Regulation 82 of Model Articles Table F of Companies Act, 2013.

The sum capitalised cannot be paid in cash, but it can be used for following [Regulation 39(ii) of Model Articles of Association Table F of Companies Act, 2013]

(A) Paying up any amounts for the time being unpaid on any shares held by such members respectively (making partly paid shares as fully paid)

(B) Paying up in full, unissued shares of the company to be allotted and distributed, credited as fully paid-up, to and amongst such members in the proportions aforesaid (bonus shares)

(C) Partly in the way specified in sub-clause (A) and partly in that specified in sub-clause (B)

Securities Premium Account and Capital Redemption Account for Bonus Shares –  A securities premium account and a capital redemption reserve account may be used for purpose of issue of fully paid bonus shares – Regulation 39(ii)(D) of Model Articles of Association Table-F of Companies Act, 2013.

3.3 Board to Act on the Basis of Ordinary Resolution in General Meeting

Bonus shares are first approved in the meeting of Board. Once bonus issued is announced on basis of Board resolution, the company cannot subsequently withdraw the same – Rule 14 of Companies (Share Capital and Debentures) Rules, 2014.

The company in general meeting, upon recommendation of Board, can pass following resolution as ordinary resolution:

(a) that it is desirable to capitalise any part of the amount for the time being standing to the credit of any of the company’s reserve accounts, or to the credit of the profit and loss account, or otherwise available for distribution; and

(b) that such sum (capitalised profit) be accordingly set free for distribution in the manner specified in Regulation 39(ii) amongst the members who would have been entitled thereto, if distributed by way of dividend and in the same proportions [Regulation 39(i) of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

After such ordinary resolution, Board can give effect to the resolution by doing all necessary acts [Articles 39(ii)(E) and 40 of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

Return of Allotment – After allotment, return of allotment has to be filed with ROC, as per procedure prescribed in rule 12 of Companies (Prospectus and Allotment of Securities) Rules, 2014 as amended on 20-1-2023.

3.4 Fractional Certificate or Payment of Cash

The ratio of issue of bonus shares may be such that some members may be entitled to fractional share.

In such case, the Board may make provisions in respect of such fractional entitlement:

(a) By the issue of fractional certificates or

(b) By payment in cash or

(c) Otherwise as it thinks fit [Regulation 40(ii)(a) of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

For this purpose, Board may authorise any person to enter into an agreement with the company for the allotment to the members additional shares credited as fully paid up. Alternatively, company can pay, on behalf of members to any unpaid amount on their existing shares [Regulation 40(ii)(b) of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

Such agreement is binding on the members.

Normally, such fractional rights are consolidated into shares and sold by the person authorised by the Board. The proceeds are then distributed among members in proportion to their fractional rights.

3.5 Effect of Issue of Bonus Shares

Bonus shares is an excellent way of bringing the paid up capital of the company in line with actual capital employed in the business. It broadens the capital base and improves image of the company.

Only fully paid bonus shares can be issued. Partly paid bonus shares cannot be issued, as it will create liability on members which they may not want.

Bonus shares are same as normal shares and members are entitled to get dividend on such shares. They can also sell the shares, if they wish. A bonus share is thought of as a gift from the company. In fact, a bonus issue simply divides the existing shares into smaller units e.g. assume that equity share capital of company is Rs. one crore and free reserves are Rs. 2.5 crores. The company is declaring dividend of 30%. If bonus shares in ratio of 1:1 are issued, the share capital will be Rs. 2 crores and free reserves will be reduced to 1.5 crores. Thus, actually, there is neither any cash payment to members nor any cash receipt from members. If market price of shares was Rs. 100 per share before issue of bonus shares, it will come down to Rs. 50 per share. Thus, the shareholder is neither a loser nor a gainer. If the company now declares 15% dividend, the shareholder will get the same amount which he was getting earlier.

Issuance of bonus shares is nothing but mere capitalisation of the profits of company in respect of which certificates are issued to the shareholders entitling them to participate in the amount of reserve but only as part of capital – Hunsur Plywood Works v. CIT (1997) 95 Taxman 460 = 229 ITR 112 (SC) – quoted with approval in Khoday Distilleries Ltd. v. CIT (2009) 176 Taxman 142 (SC), where it was held that there is no element of gift in a company issuing bonus shares.

In issue of bonus shares, there is no cash inflow. After issue of bonus shares, the paid up capital comes to more realistic levels. Dividend declared on increased capital appears more reasonable. It does not look very high. Really, bonus shares is only a book entry.

Issue of bonus shares is considered a sign of healthy company and company which issues bonus shares periodically is well appreciated in share market.

3.6 When Right to Bonus Crystallises

In Shri Gopal Paper Mills v. CIT AIR 1970 SC 1750 = 37 Comp Cas 240 = 77 ITR 543 (SC), it was held that shareholder becomes owner of shares on date of resolution. It is not necessary for issue of shares that a share certificate has to be given. It can be given later. Vesting of bonus shares takes place from date of company’s resolution and not from date of actual allotment.

3.7 Expenses in Issue of Bonus Shares Are Revenue Expenses

In CIT v. General Insurance Corporation (2006) 156 Taxman 96 (SC), it has been held that expenditure incurred in connection with bonus shares is revenue expenditure. – same view in Bombay Burmah Trading v. CIT (1984) 145 ITR 793 = 12 Taxman 178 (Bom HC).

Earlier, in Gujarat Steel Tubes v. CIT (1994) 210 ITR 358 (Guj), it was held that expenses incurred in issue of bonus shares are capital in nature and cannot be allowed as expenditure. – quoted and followed in CIT v. Bharat Vijay Mills (2002) 124 Taxman 60 (Guj HC DB). Now these decisions stand overruled.

3.8 Bonus Shares Cannot Be Issued Out of Revaluation Reserves

Proviso to section 63(1) of Companies Act, 2013 [Corresponding to section 205(3) of the 1956 Act] specifically prohibits issue of fully paid bonus shares by capitalising reserves created by revaluation of assets.

In the 1956 Act, there was no such specific prohibition.

3.9 Bonus Shares, Dividend Are Accretions to Pledged Stock

In Standard Chartered Bank v. Custodian 2000 AIR SCW 1443 = AIR 2000 SC 1488 = 25 SCL 221, it was held that if shares are pledged as security with bank, bonus shares, dividend and interest in respect of pledged securities would be accretion to the pledged stock and have to be regarded as forming part of pledged property. The accretion will remain with the pawnee and the accretion can be dealt with in the same manner as the pledged shares. [As per section 163 of Contract Act, accretions in respect of goods must be returned when the goods bailed are returned]. It was observed – ‘Bonus share is an accretion. A bonus share is issued when the company capitalised its profits by transferring an amount equal to the face value of the share from its reserve to the nominal capital. In other words, the undistributed profit of the company is retained by the company under the head of capital against the issue of further shares to its shareholders. Bonus shares have, therefore, been described as a distribution of capitalised undivided profit. A bonus share is a property which comes into existence with an identity and value of its own and capable of being bought and sold as such. Thus, bonus shares is an accretion.

3.10 Making Partly Paid Shares Fully Paid Up By Bonus Issue

As per Regulation 39(ii) of Table F of Companies Act, 2013, amount standing to credit of company’s reserve account, or to credit of profit and loss account or otherwise available for distribution, can be used for following:

(i) Making partly paid shares as fully paid

(ii) Issuing fully paid shares (termed as bonus shares) in proportion to their existing shareholding

(iii) Partly for making shares fully paid up and partly for issuing fully paid-up bonus shares.

This is also permitted under proviso to section 123(5) of Companies Act, 2013 [Corresponding to section 205(3) of the 1956 Act].

As per Regulation 39(3) of Table F of Companies Act, 2013, share premium account and capital redemption reserve can be utilised only for issue of fully paid bonus shares. In other words, these reserves cannot be used for making partly paid shares fully paid up. Other reserves and surplus profits can be used either for making partly paid fully paid up or issuing fully paid-up bonus shares.

3.11 Issue of Bonus and Rights Shares to be Kept in Abeyance if Transfer of Shares Not Registered

As per section 59(4) of Companies Act, 2013, a public limited company can refuse to register a transfer if the proposed transfer is against provisions of Law.

As per section 58(1) of Companies Act, 2013, a private company can decline transfer in pursuance of powers under its articles. Sometimes, there may be stay of Court on such transfer.

The question is what is the legal position if a public company does not transfer shares as the transfer is against any law or if there is stay from Court or a private company refuses proposed transfer as it is against Articles of the company.

Where any instrument of transfer of shares has been delivered to any company for registration and the transfer of such shares has not been registered by the company for any reason, the company shall keep in abeyance in relation to such shares, any offer of rights shares under section 62(1)(a) and any issue of fully paid-up bonus shares in pursuance of first proviso of section 123(5) – section 126(b) of Companies Act, 2013.

3.12 Income Tax Aspects of Bonus Shares

Where bonus shares are issued, they become capital assets of the shareholder. There is no tax payable when bonus shares are received by shareholder. However, capital gains tax is attracted if bonus shares are sold by shareholder. The cost of bonus shares will be taken as ‘Nil’ for calculation of capital gains, if the shares were acquired after 1-4-1981 – section 55 of Income Tax Act.

The crucial date for the purpose of reckoning the period of holding is the date on which bonus shares were issued and not the date of purchase of original shares which gave rise to bonus shares. – Explanation I(f) to section 2(42A) of Income Tax Act.

3.13 Bonus Debenture

In Astra Zeneca Pharma India Ltd., In re (2010) 97 SCL 51 (Karn HC), a scheme of issuing fully paid non-redeemable debentures from general reserves was approved.

3.14 Bonus Shares under FEMA

Regulation 6A of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 allows issue of bonus shares by Indian company to its non-resident shareholders. Original shares should have been acquired by shareholder as per rules/regulations. The bonus shares will be subject to same restrictions about repatriability as applicable to original shares.

After bonus issue, report should be submitted to regional office of RBI in form FC-GPR, where registered office of company is situated, within 30 days [Regulation 6B of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000]

4. Sweat Equity Shares

Sometimes, an employee/director may be having * know how or * rights in the nature of intellectual property rights (e.g. patent or copyright) or * providing value addition. In such cases, a new and relatively unknown company may not be in a position to reimburse him through cash. Instead the company may offer him equity shares. Such offer of equity in company also encourages employees to join a new and relatively unknown company and give his know-how. In absence of such incentive, a person may not be willing to leave job in a big and reputed company and join a relatively new and unknown company.

Sweat Equity is a reward for hard work done or using intellectual property for benefit of company. As per Black’s Law Dictionary, ‘sweat equity’ means financial equity created in property by the owner’s labour in improving property.

Statutory Provisions for Sweat Equity – Section 53 of Companies Act, 2013 [Corresponding to section 79A of the 1956 Act] makes provision of issue of ‘sweat equity’ to directors or employees. It is termed as ‘sweat equity’ as it is earned by ‘sweat’ by employees (i.e. by hard work). Though it is termed as ‘sweat equity’, the employees become happy and hence is ‘sweet equity’ for them.

‘Sweat equity shares’ means such equity shares as are issued by a company to its directors or employees at a discount or for consideration other than cash, for their providing knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called – section 2(88) of Companies Act, 2013 [Corresponding to Explanation II to section 79A(1) of the 1956 Act].

The provisions are as follows:

• ‘Sweat Equity Shares’ means equity shares issued by company to its employees or directors at a discount or for consideration other than cash.
• The ‘consideration other than cash’ may be for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called. Thus, the right may be ‘Patent’ or ‘Copyright’ or it may be similar to patent or copyright.
• Shares of a class which have already been issued only can be issued as ‘Sweat Equity Shares’ [section 54(1) of Companies Act, 2013]
• Issue of ‘sweat equity shares’ should be authorised by a special resolution by the company in general meeting. The resolution should specify number of shares, current market price, consideration, if any and class or classes of directors or employees to whom the ‘sweat equity shares’ may be issued [section 54(1)(b) of Companies Act, 2013]
• Omitted w.e.f. 7-5-2018. [Till 7-5-2018, section 54(1)(c) of Companies Act, 2013 provided that the sweat equity shares can be issued only one year after the company was entitled to commence business]
• If the company is listed on stock exchange, ‘sweat equity’ shares can be issued as per regulations made by SEBI. If company is not listed on stock exchange, sweat equity shares will be issued in accordance with guidelines which may be prescribed by Central Government [section 54(1)(d) of Companies Act, 2013]
• The ‘sweat equity shares’ have same limitations, restrictions and rights as are applicable to other equity shares. The holders of such shares shall rank pari passu with other equity shareholders – section 54(2) of Companies Act, 2013 [corresponding to section 79A(2) of the 1956 Act]

Provisions in Listed of Listed Companies – SEBI (Issue of Sweat Equity) Regulations, 2002 make provisions for issue of sweat equity to employees/directors of listed company.

Provisions in Case of Unlisted Company – An unlisted company can issue sweat equity shares by complying with provisions of rule 8 of Companies (Share Capital and Debentures) Rules, 2014. The explanatory statement should contain specified particulars. Special resolution is to be passed, which is valid for twelve months from date of resolution. Sweat equity shares cannot exceed 15% of existing paid up capital or shares of issue value of Rs five crores, whichever is higher. Total sweat equity shares cannot exceed 25% of paid up equity capital of company at any time. The sweat equity shares have lock in period of three years. The sweat equity shall be treated as part of managerial remuneration, if issued to manager and the consideration does not form part of assets of the company in balance sheet. Disclosure shall be made in report of Board of Directors. Register of sweat equity shares shall be maintained in form SH.3.

Special Provisions in Case of Startup Company – In case of startup company, it can issue sweat equity shares not exceeding 50% of its paid up capital upto ten years (till 5-6-2020 the words were ‘five years’) from date of incorporation or registration – second proviso to rule 8(4) of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 19-7-2016 and amended on 5-6-2020.

Start-up company means company as defined in G.S.R. 127(E), dated 19-2-2019 issued by the Department for Promotion of Industry and Internal Trade [Amendment dated 5-6-2020].

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Risk Management in Banking refers to the process through which banks identify, measure, monitor, and control various financial and operational risks arising from their business activities to ensure financial stability, profitability, and regulatory compliance. It involves managing risks such as credit risk, liquidity risk, interest rate risk, market risk, and operational risk through structured policies, asset liability management (ALM), internal controls, and regulatory frameworks to protect depositors’ funds and maintain the soundness of the banking system.

Table of Contents

1. Risk–an Integral Part of Banking
2. Paradigm Shift in Banking Operations
3. Banking Operations and Risk Exposure
4. Classification of Risk

Check out Taxmann's Management of Banks – Text & Cases which is a comprehensive and analytically rigorous treatise that presents banking as an integrated management discipline rather than a purely theoretical subject. It systematically links the Indian banking system's regulatory framework with bank financial architecture (balance sheet analysis, profitability, ALM), risk governance under Basel norms, and asset quality management within the IBC regime. The book further addresses retail banking strategy, CRM and E-CRM, digital payment systems, international banking, and emerging policy themes such as Viksit Bharat 2047 and the IBC Amendment Bill 2025. Built on a structured Text & Cases methodology, it combines conceptual depth with practical case analysis to strengthen analytical clarity and managerial decision-making in modern banking.

1. Risk–an Integral Part of Banking

Risk is an integral part of banking as banks primarily trade in risk in the process of maturity transformation in terms of difference in interest rate of assets and liabilities. Also, banking business operations are many and varied. Commercial banking, corporate finance, retail banking, trading and investment banking and various financial services form the main business operations of banks. Therefore, banks cannot afford to be risk avoiders. At the same time ‘banker’s prudence’, something that is critical to safety of the depositors’ funds, has to be the underlying philosophy at all times. The risk return relationship has to be optimally balanced for welfare enhancing outcomes.

2. Paradigm Shift in Banking Operations

Business Operations	Sub-Groups	Functions
Corporate Finance	Corporate Finance,  Muncipal/government finance, Merchant banking and advisory services	Mergers and acquisitions, underwriting, Privatisations, Securitisation, IPO, government debt
Trading and Sales	Sales, Market making, Treasury prime brokerage	Fixed income, equity, foreign exchanges, credit, funding, lending and repos, brokerage, debt
Retail Banking	Retail Banking	Retail lending and deposits, banking services, trust and sales
Private Banking	Private Lending and Card Services	Deposits, banking services, trust and estates, investment advice merchant/commercial/cards and retail
Commercial Banking	Commercial Banking	Project finance, real estate, export finance, trade finance, leasing, bills of exchange
Payments and Settlement	External clients	Payments and collection, funds transfer, clearing and settlement
Agency Functions	Custody	Escrow, depository receipts, securities lending
Asset Management	Discretionary and non-discretionary fund  management	Pooled, segregated, retail, institutional, closed, open

The banking business has become far more sophisticated and complex. Risk too, has increased in proportion to this sophistication and complexity. The risk taking behaviour of banks has high potential for contributing to and amplifying systemic risk and consequent contagion. This can have severe repercussions for financial and economic fragility as witnessed during and in the aftermath of the global financial crisis.

The growing awareness on risk management can be accounted to following developments in the financial sector over the last couple of decades:

• The deregulation of financial markets (deregulation of saving rate and interest rate) coupled with increased volatility.
• The diversification of activities of banks from the traditional function of lending and borrowing to activities including, inter alia, custodial services, securities underwriting, project financing and corporate advisory.
• The emergence of complex global financial institutions coupled with the growing inter-connectedness of the financial system (Quantitative Easing in US and its impact on Indian financial market).
• BASEL reforms (from BASEL I to BASEL III) also added to the process by increasingly requiring banks to maintain capital in accordance with their risks.
• The increasing trading of securities and derivative products along with increasing growth of complex financial products.
• As new complex products proliferated in the market place, their valuation posed challenges due to lack of depth and width of the financial market and financial illiteracy.

3. Banking Operations and Risk Exposure

To manage the balance sheets, Indian Banks have been focusing on mobilisation of deposits, comply the statutory reserve requirements to avoid default and to extend credits to meet the requirements of finance for working capital with all segments of industry. Depositors are becoming more and more sensitive to the new opportunities for getting best maturity yield for the surplus funds. While depositors in the household try to shift their portfolio of savings to augment their returns, the corporate treasurers are today constantly in search to optimise their returns. The change has made banks more accountable about the quality of assets through better management of risks, both on the assets and liabilities sides. The risks include not only the traditional risk of write-off but also maturity mismatch risk, interest rate risk, liquidity risk, market risk, operational risk etc.

Commercial Banks major operation includes all advances, deposits and borrowings, which usually arise from commercial and retail banking operations. All assets and liabilities in Balance sheet of the bank includes following features:

1. They are normally held until maturity
2. Accrual system of accounting is applied

Maturity mismatch between assets and liabilities results in excess or deficit of liquidity that leads to liquidity risk. In the Indian banking scenario, the liabilities are predominately at fixed rates whereas among assets, the loan assets bear floating interest rate and the investment assets bear fixed interest rate. Also, interest rate changes makes impact on assets and liabilities held till maturity affecting net-interest margin results in interest rate risk.

It can be summarised that financial risk can be defined as the probability of variation of actual return from the expected return. The probability is governed by symmetry of information. Further the outcome is dependent on several other factors such as macroeconomic fundamentals of the country comprising of level of inflation, interest rate, level of capital formation, saving and consumption propensity of Indian consumers, international trade scenario, political stability, depth of capital market, technological upgradation, innovative financial products, corporate governance and financial penetration in India.

4. Classification of Risk

For efficient risk management in banks and financial institutions one need to understand the various categories and intricacies of risk and how to manage and mitigate it.

4.1 Liquidity Risk

The bank is exposed to such risk due to its banking activities like – Withdrawal of deposits, repayment of purchased funds at maturity, extensions of credit and working capital needs etc.

• Tool for monitoring liquidity is the maturity mismatch analysis
• The assessment of bank’s liquidity during stressed conditions is conducted by various stress tests at regular intervals. The liquidity position of overseas branches are reviewed by bank’s ALCO

Dimensions of Liquidity Risk

• Funding Risk – Unanticipated withdrawals/non-renewal of deposits (wholesale/retail)
• Time Risk – Need to compensate for non-receipt of expected inflow performing assets turning into NPAs
• Call Risk – Due to crystallisation of contingent liabilities and unable to undertake profitable business opportunities when desirable.

Liquidity Risk – Measurement

For Liquidity Risk Measurement two methods are employed:

1. Stock Approach – Key Ratios are – Loan to Asset Ratio, Loan to Core Deposits, Large liabilities less Temporary investments to Earning assets less Temporary investments, Purchased Funds to Total Assets, Loan losses/net loans.
2. Cashflow Approach – As per RBI guidelines, commercial banks have to allocate the cash outflows and inflows in different residual maturity period known as time buckets. Earlier banks used to divide the assets and liabilities in 8 maturity buckets (1-14 days; 15-28 days; 29-90 days; 91-180 days; 181-365 days, 1-3 years and 3-5 years and above 5 years), based on residual maturity period . Since September, 2007, the banks have adopted a more comprehensive approach to measure liquidity risk by splitting the first time bucket of 1-14 days into three time buckets viz., next day, 2-7 days and 8-14 days. Thus, now banks have 10 time buckets.

After allocating assets and liabilities in 10 time buckets, the bank has to match different time bucket assets with the corresponding bucket of the liability. When assets of the bank are more than its liabilities in a particular time bucket, bank has surplus liquidity. In case bank’s liabilities exceed its assets in a particular time bucket the bank has liquidity crunch position and depending upon the interest rate movement, such situation may turn out to be risky for the bank. Banks monitor such mismatches and take appropriate steps to minimise their interest rate risk exposure during a specific period of time.

4.2 Interest Rate Risk

Banks are now operating in a free and deregulated interest rate regime and hence prone to risks arising out of adverse movement in interest rates. Apart from liquidity risk, Interest rate risk is another major risk area that banks are exposed to in the deregulated environment, since taking excess interest rate risk may erode bank’s earnings and its capital base, thus raising concern for the bank by stakeholders and regulator alike.

Asset Liability Management is concerned with risk mitigation and provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity and commodity price risks of a bank that needs to be integrated with the banks’ business strategy. With the deregulation of interest rate, increase in inflation rate frequent changes in the domestic interest rates, banks have been exposed to the higher level of Interest rate risk, credit risk and market risks.

The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. To achieve these objectives, it is essential that banks have to monitor, maintain and manage their assets and liabilities portfolios in a systematic manner taking into account the Interest rate risk involved in these areas. Interest rate risk is the risk where changes in market interest rates might adversely affect a bank’s financial condition.

The immediate impact of changes in interest rates is on the Net Interest Income (NII). A long term impact of changing interest rates is on the bank’s net worth since the economic value of a bank’s assets, liabilities and off-balance sheet positions get affected due to variation in market interest rates.

The Net Interest Income of the bank is an outcome of the interest rate because of the mismatch and the earning of the bank would be volatile with movement of interest rates on assets and liabilities because of the ALM mismatch.

Interest Rate Risk and Asset Liability Mismatch

Single asset or liability management is a simple task, suppose Punjab National Bank has created an asset at Basic Prime Lending Rate (BPLR) at 12% for 4 years, for Rs. 10 crore for an AAA corporate. However subsequently, because of rate on interest going up, due to higher rate of inflation, the BPLR was revised to 13%, then the value of the asset will depreciate, although as per accounting the value of the asset is Rs. 10 crore in nominal terms but real terms the value is lower than Rs. 10 crore (there is inverse relationship between interest rate and value of asset). Although for accounting purpose, the depreciation on the trading portfolio is important, for an ALM manager, the net value of the portfolio is important as both economic value as well as accounting value is of concern to the ALM manager. For risk management, limits are prescribed for fall in value due to adverse change in interest rate so as to keep the negative impact at the minimum.

In banking industry ALM is a very complex process as it consists of millions of assets and liabilities of different time period, varying rate of interest with different re-pricing nature and also having different residual/behavioural maturity. Hence banks should be very vigilant in measuring and managing interest rate risk.

Interest Rate Risk (IRR) can be viewed from two perspectives:

1. Its impact on earnings of the bank due to holding assets and liabilities and off balance sheet items with different maturity dates or re-pricing dates.
2. Its impact on the economic value of the bank’s assets, liabilities and off balance sheet positions through GAP Analysis.

Basis Risk

A gap or mismatch risk arises from holding assets and liabilities and off balance sheet items with different maturity dates or re-pricing dates, thereby creating exposure to unexpected changes in the level of market interest rates. For example – an asset maturing in two years at a fixed rate of interest have been funded by a liability maturing in six months or a liability maturing over a period but getting re-priced periodically. The interest margin would undergo a change after six months/re-pricing period, causing variation in net interest income.

The risk that the interest of different assets, liabilities and off-balance sheet items may change in different magnitude is termed as Basis risk.

Example – In a rising interest rate scenario asset interest rate may rise in different magnitude than the interest rate on corresponding liability creating variation in net interest income.

The degree of Basis risk is fairly high in respect of banks that create composite assets out of composite liabilities. The Loan book in India is funded out of a composite liability portfolio and is expected to a considerable degree of basis risk

The basis risk is quite visible in volatile interest rate scenarios. When the variation in market interest rate causes the NII to contract, the basis has moved against the banks.

In a floating interest rate scenario, banks may price their assets and liabilities based on different benchmarks, i.e. treasury bills’ yields, fixed deposit rates, call money rates, MIBOR, etc. In case the banks use two different instruments maturing at different time horizon for pricing their assets and liabilities, any non-parallel movements in yield curve would affect the NII.

Embedded Option Risk

When a liability raised at a rate linked to say 91 days Treasury bill is used to fund an asset linked to 364 days treasury bills. In a rising Interest rate scenario both, 91 days and 364 days treasury bills may increase but not equally due to non-parallel movement of yield curve creating a variation in net interest earned.

Significant changes in market interest rates create the source of risk to banks’ profitability by encouraging prepayment of cash credit/demand loan term loan exercise of call/put options on bonds/debentures and/or premature withdrawal of term deposits before their stated maturities. The embedded option risk is becoming a reality in India and is expected in volatile situations.

The higher and faster the magnitude of changes in interest rate, the greater will be the embedded option risk to the banks’ NII. The result is reduction of projected cash flow and income for the bank.

Measurement of Interest Rate Risk – GAP ANALYSIS

The Interest rate risk can be measured and managed by assessing the position of risk sensitive assets and liabilities. Banks do Gap analysis by grouping rate sensitive liabilities, assets and off balance sheet positions into time buckets according to residual maturity or next re-pricing period, whichever is earlier. The difficult task in Gap analysis is determining rate sensitivity. All investments, advances, deposits, borrowings, purchased funds etc. that mature/re-price within a specified timeframe are interest rate sensitive. Similarly, any principal repayment of loan is also rate sensitive if the bank expects to receive it within the time horizon. This includes final principal payment and interim instalments.

Certain assets and liabilities receive/pay rates that vary with a reference rate. These assets and liabilities are re-priced at pre-determined intervals and are rate sensitive at the time of re-pricing. While the interest rates on term deposits are fixed during their currency, the advances portfolio of the banking system is basically floating. The interest rates on advances could be re-priced any number of occasions, corresponding to the changes in Prime lending rate. To evaluate earnings exposure, interest rate sensitive liabilities in each time band are subtracted from the corresponding interest rate sensitive assets to produce a re-pricing ‘gap’ for that time bucket. This gap can be multiplied by an assumed change in interest rates to yield an approximation of the change in net interest income that would result from such an interest rate movement. The size of the interest rate movement used in the analysis can be based on variety of factors, including historical experience, simulation of potential future interest rate movements, and the judgment of bank management.

• A negative or liability-sensitive gap occurs when liabilities exceed assets (including off balance sheet positions) in a given time bucket. In other words, an increase in market interest rates could cause a decline in net interest income.
• A positive or asset-sensitive gap occurs when assets exceed liabilities. This means that a decrease in market interest rates could cause a decline in net interest income.

GAP ti = Rate Sensitive Assets (RSA) ti – Rate Sensitive Liabilities (RSL) ti

Where; ti is for ith time bucket

• If RSA > RSLs of the bank as a whole, then GAP is Positive, Bank is called Asset Sensitive
• If RSA < RSLs of the bank as a whole, then GAP is Negative, Bank is called Liability Sensitive

The Gap reports indicate whether the institution is in a position to benefit from rising interest rates by having a positive Gap (RSA > RSL) or whether it is in a position to benefit from declining interest rates by a negative Gap (RSL > RSA). The Gap can, therefore, be used as a measure of interest rate sensitivity.

The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. To achieve these objectives, it is essential that banks have to monitor, maintain and manage their assets and liabilities portfolios in a systematic manner taking into account the Interest rate risk involved in these areas.

Illustration – Interest Rate Sensitive Gap

Time Buckets	Assets	Liabilities	GAP	Cumulative Gap
1 day	717.92	311.07	406.85	406.85
2-7 days	1,160.10	2,677.23	-1,517.13	-1,110.28
8-14 days	1,340.81	2,285.23	-944.42	-2,054.70
15-28 days	602.99	3,800.99	-3,198.00	-5,252.70
29 days to 3 months	3,319.55	12,036.66	-8,717.11	-13,969.81
Over 3 months to 6 months	3,350.04	9154.08	-5,804.04	19,773.85
Over 6 months to 1 year	18,930.11	6,576.91	12,353.20	-7,420.65
Over 1 year to 3 years	14,393.72	8,109.83	6,283.89	-1.136.76
Over 3 years to 5 years	5,513.33	4,115.67	1,397.66	260.90
Over 5 years	5,773.27	4,211.56	1,561.7	1,822.61

The above table depicts that the bank have short term negative gap and long term positive gap. Considering the cumulative gap of one year is Rs. 7,420.65 crore. If the short term interest rate increases by 1%, the Net Interest Margin of the bank will be reduced by Rs. 74.20 crore. Bank can eliminate liability sensitive gap by extending the liability maturity or shorten the asset maturities so that refinancing risk (arising due to refinancing need for long term assets by borrowing funds at a higher rate of interest from the market) can be mitigated.

If in above case rate sensitive assets were greater than rate sensitive liabilities for a period of one year, the bank with decrease in interest rate would have gained lower net interest margin. This positive asset sensitive gap would have exposed the bank to reinvestment risk as assets at the date of maturity need to be reinvested at lower rate of interest. Hence the bank can mitigate reinvestment risk by extending the maturity of assets or shortening the liability maturities.

4.3 Credit Risk

The definition in a layman’s language is essentially the risk that a loan will not be repaid or that a borrower will be unable to make payment of interest or principal in a timely manner.

The exposure of Credit Risk of banks varies depending on effectiveness of:

1. Loan Policy
2. Credit Monitoring Policy
3. Real Estate Policy
4. Credit Risk Management Policy
5. Collateral Risk Management Policy
6. Recovery Policy
7. Treasury Policy

Credit risk is most simply defined as the potential that a bank’s borrower or counterparty may fail to meet its obligations in accordance with agreed terms. It is the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or a counterparty to meet commitments in relation to lending, trading, hedging, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio arising from actual or perceived deterioration in credit quality.

Credit Risk is Made Up of Two Components:

1. Risk Transaction Risk (Default Risk), which represents the risk arising from individual credit exposure
2. Portfolio Risk, which represents the risk inherent in the portfolio of credit assets (concentration of assets, correlation among portfolios, etc.)

For most banks, loans are the largest and the most obvious source of credit risk; however, credit risk is found in varieties of transactions across the banks’ portfolio including in the banking book and in the trading book, and both on and off balance sheet. Banks increasingly face credit risk (or counterparty risk) in various financial instruments other than loans, including acceptances, inter-bank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options and in guarantees and settlement of transactions.

Banks Frame Their Credit Risk Policy to Achieve the Following Key Objectives:

• Monitoring concentration risk in particular products, segments, geographies etc. thereby avoiding concentration risk from excessive exposures to any particular products, segments and geographies.
• Assisting in building quality credit portfolio and balancing risks and returns in line with bank’s risk appetite.
• Tracking credit quality migration on a regular basis.
• Determining how much capital to hold against each class of the assets.
• Undertaking Stress testing to evaluate the credit portfolio strength.
• To develop a greater ability to recognise and avoid potential problems.
• Alignment of risk mitigation strategy with business objectives in adherence to RBI’s guidelines.

The goal of credit risk management is to maximise a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio, as well as, the risk in the individual credits or transactions.

Loan Review and Risk Migration

Prior to extending a credit a bank (or any other lender) has to obtain all required information about the borrower. This is done through a proper scan of the borrower’s annual income, existing debts, ownership of house etc. A standard formula is applied to the information extracted to produce a number called the Credit score. Based on this credit score, the lending firm decides whether or not to extend credit.

After sanction of the credit limit, banks need to evaluate the performance of the borrowal accounts and assess the financial health of the credit portfolio. The loan review mechanism gives an indication of the risk migration and reliability and robustness procedure used at the time of assuming credit risk. In assessing credit risk from counterparty (the uncertainty in counterparty’s ability to meet obligations), an institution must consider 3 issues –

• Default Probability – The likelihood that the counterparty will default on its obligation over the life of its obligation.
• Credit Exposure – The size of the outstanding obligation in the event of default.
• Recovery Rate – The fraction of the exposures that can be recovered through bankruptcy proceedings or other forms of settlement, in the event of default.

In the rating process to assess credit risk, the first step should be examination of the character of the applicant/promoter including integrity, honesty and values. The credit should be granted with due diligence and detailed insight into the customer’s circumstances and of specific assessments that provide a context for such credits. The credit facility should be granted based on the customer’s credit worthiness, capital base or assets to assure that the customer is able to substantiate the repayment. Due regard should be placed to the industry in which customer is operating the business specific risks and management capability and their risk appetite.

The forms of credit risks associated with large Institutions are often complicated and unique. The term Credit analysis is used to any process for assessing the credit quality of such firms. The credit analysis of a firm is done through the review of its Balance sheet, Income statement, recent trends in the industry, economic environment etc. Based on the information extracted, the credit analyst assigns the counterparty a credit rating which is used for making credit decisions. Credit Analysis is an ongoing process applicable at each transaction level. The prime objective of managing credit risk at each transaction level is development and evaluation and monitoring system that covers the entire life cycle of the exposure i.e.; opportunity for transaction, assessing credit risk, granting of credit, disbursement and subsequent monitoring, identifying the obligors (corporate, SMEs, trader and schematic loans such as home loan, personal loan, etc.) with emerging credit problems, remedial action in event of credit quality deterioration and repayment or termination of the obligation.

Many banks, insurance companies, investment managers etc. hire their own credit analyst for preparing credit ratings for their internal use. Certain agencies like Standard & Poor, Moody’s & Fitch etc are in business of developing credit ratings for use by investors, lenders and third parties. Banks should have a keen awareness of the need to identify measure, monitor and control credit risk, as well as, to determine that they hold adequate capital against these risks and they are adequately compensated for risks incurred.

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Consultation Paper; Dated: 12.05.2026

Click Here To Read The Full Update

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Case Details: Parmeshwar Gorain vs. U.P. Power Corporation Ltd. [2026] 185 taxmann.com 839 (Allahabad)

Judiciary and Counsel Details

• J.J. Munir, J.
• Manu Mishra for the Petitioner.
• Abhishek Srivastava & K.K. Rao for the Respondent.

Facts of the Case

In the instant case, the petitioner, a Junior Engineer of the respondent power corporation, was arrested in a trap case for allegedly demanding and accepting illegal gratification from a consumer for the installation of a 25 KVA transformer.

A departmental charge-sheet was issued alleging that the petitioner had demanded and accepted illegal gratification from the consumer and was caught red-handed. The petitioner submitted his reply denying the charges.

Thereafter, the Inquiry Committee fixed a date for personal hearing, pursuant to which the petitioner appeared, his statement was recorded, and certain documents were supplied to him.

Subsequently, the Inquiry Committee submitted its report holding the charges to be proved, and the Managing Director passed an order dismissing the petitioner from service. It was observed that the fixing of a date, time, and place for holding the inquiry did not merely contemplate recording the delinquent employee’s statement and hearing him personally before the Inquiry Committee. Rather, such date, time, and place were required to be fixed for the purpose of permitting the establishment to lead evidence in support of the charges.

The delinquent employee could have been called upon to adduce evidence in his defence only after the establishment had examined its witnesses and produced all supporting evidence. Further, the witnesses of the establishment were required to be made available to the delinquent employee for cross-examination.

Similarly, if the delinquent employee produced evidence in his defence, including witnesses, such witnesses were also required to be made available to the establishment for cross-examination. However, no such procedure was followed in the present case.

High Court Held

Accordingly, the High Court held that the impugned order of dismissal was liable to be quashed, and directed reinstatement of the petitioner in service forthwith, while granting liberty to the respondents to proceed afresh against the petitioner on the basis of the same charge-sheet.

List of Cases Referred to

• State of U.P. v. Aditya Prasad Srivastava 2017 (2) ADJ 554 (DB) (LB) (para 19)
• Smt. Karuna Jaiswal v. State of U.P. 2018 (9) ADJ 107 (DB) (LB) (para 19)
• State of U.P. v. Kishori Lal 2018 (9) ADJ 397 (DB) (LB) (para 19)
• State of Uttaranchal v. Kharak Singh 2008 taxmann.com 10993 (SC) (para 19)
• Roop Singh Negi v. Punjab National Bank [2009] 2008 taxmann.com 11735 (SC) (para 19)
• State of Uttar Pradesh v. Saroj Kumar Sinha [2010] 2 SCC 772 (para 19)
• Satyendra Singh v. State of U.P. [2025] 11 taxmann.com 1268 (SC) (para 20).

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IFSC Press Release, Dated: 12.05.2026

The International Financial Services Centres Authority (IFSCA) has issued the “Master Circular for Broker Dealers and Clearing Members”, consolidating the regulatory framework applicable to entities operating in GIFT IFSC into a single comprehensive instrument.

1. Objective of the Master Circular

The circular aims to:

• Consolidate existing regulatory instructions and requirements
• Enhance clarity, consistency, and ease of compliance
• Provide a unified compliance framework for market intermediaries in IFSCs

2. Key Areas Covered

2.1 Registration Requirements

Framework relating to registration and eligibility of:

• Broker Dealers
• Clearing Members

2.2 Governance and Conduct

Prescribes standards for:

• Corporate governance
• Conduct and compliance obligations

2.3 Operational and Technology Requirements

Covers:

• Operational procedures
• Technology and system requirements

2.4 Risk-Based Supervision

• Includes provisions for risk-based supervisory mechanisms
• To strengthen regulatory oversight and monitoring

2.5 Business Continuity and Resilience

Prescribes norms relating to:

• Business Continuity Planning (BCP)
• Disaster recovery arrangements

2.6 Vendor Risk Management

Provides guidance on outsourcing and vendor management controls

2.7 Compliance Reporting

• Specifies reporting and disclosure obligations to IFSCA

3. Regulatory Significance

The Master Circular creates:

• A centralised reference framework for Broker-Dealers and Clearing Members
• Supporting efficient compliance and regulatory administration in GIFT IFSC

4. Conclusion

The issuance of the Master Circular strengthens the regulatory ecosystem for intermediaries operating in GIFT IFSC by consolidating governance, operational, supervision, and compliance requirements into a unified framework.

Click Here To Read The Full Press Release

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Consultation Paper; Dated: 12.05.2026

Click Here To Read The Full Update

The post SEBI Proposes Higher Position Limits for Agri Commodity Derivatives appeared first on Taxmann Blog.

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Editorial Team – [2026] 186 taxmann.com 499 (Article)

1. Introduction

The implementation of Indian Accounting Standards (Ind AS) significantly changed the manner in which companies prepare and present financial statements in India. Unlike the earlier Accounting Standards framework, Ind AS introduced concepts such as fair valuation, Other Comprehensive Income (OCI), hedge accounting, revaluation adjustments and transition accounting.

While these accounting changes improved transparency and global comparability, they also created practical challenges in the computation of Minimum Alternate Tax (MAT). This is because MAT is levied on the “book profit” of a company, and under Ind AS, several gains and losses are recognised outside the traditional Statement of Profit and Loss.

To address this issue, special provisions were introduced to govern the computation of MAT in case of Ind AS-compliant companies. The intention behind these provisions was to ensure that unrealised and notional accounting adjustments do not result in artificial MAT liability merely because of accounting presentation requirements under Ind AS.

This article explains the MAT framework applicable to Ind AS-compliant companies in a simplified and practical manner with illustrations and numerical scenarios.

2. Understanding MAT Under the Income Tax Framework

Minimum Alternate Tax is designed to ensure that companies reporting substantial accounting profits also pay a minimum level of tax, even if taxable income under normal provisions is low because of exemptions, deductions or incentives. Accordingly, companies are required to pay tax either under the normal computation mechanism or on “book profit”, whichever is higher.

Therefore, the concept of “book profit” assumes significant importance. Under the traditional accounting framework, book profit was derived largely from the net profit disclosed in the Statement of Profit and Loss, subject to specified additions and deductions. However, the position became more complicated after the implementation of Ind AS because several gains and losses started getting recognised through Other Comprehensive Income instead of profit or loss.

As a result, special MAT adjustments became necessary in order to appropriately capture the impact of Ind AS accounting.

3. Concept of Other Comprehensive Income (OCI)

Under Ind AS, the financial performance of a company is no longer restricted only to the profit or loss reported in the Statement of Profit and Loss. Companies are also required to present “Other Comprehensive Income” which includes specified gains and losses recognised directly in equity instead of profit or loss. The aggregate of profit or loss and OCI is presented as “Total Comprehensive Income”.

OCI generally contains unrealised gains and losses arising from fair valuation or re-measurement exercises. Common examples include revaluation gains on property, plant and equipment, actuarial gains and losses on defined benefit obligations, fair value changes in investments classified as FVTOCI, foreign currency translation adjustments and certain hedge accounting reserves.

For MAT purposes, the treatment of OCI items depends upon whether such items will subsequently be reclassified to profit or loss or whether they will permanently remain outside the Statement of Profit and Loss. This distinction becomes extremely important while computing book profit.

4. Understanding the Calculation of Book Profit

Minimum Alternative Tax (MAT) is computed on the book profit of a company. Book profit means net profit as shown in the statement of profit & loss, as increased and decreased by certain specified items. So, the first and most important step while calculating MAT is to compute the book profit.

The CBDT has issued a circular stating that the book profit of Ind-AS-compliant companies should be calculated based on the book profit computed as per the existing provisions of Section 206, which shall be further:

a) Increased by amounts of OCI items credited to other comprehensive income in the statement of profit & loss under the head ‘Items that will not be re-classified to profit or loss’

b) Decreased by amounts of OCI items debited to other comprehensive income in the statement of profit & loss under the head ‘Items that will not be re-classified to profit or loss’

c) Increased by the amount debited to the statement of profit & loss on distribution of non-cash assets to shareholders in a demerger in accordance with Appendix A of Ind AS 10 (Events after the Reporting Period)

d) Decreased by the amount credited to the statement of profit & loss on distribution of non-cash assets to shareholders in a demerger in accordance with Appendix A of Ind AS 10 (Events after the Reporting Period).

Click Here To Read The Full Article

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Bijoy Das – [2026] 186 taxmann.com 438 (Article)

The Section 536(2)(b) Savings Clause, CBDT Circular 789/2000’s Post-Repeal Status, Form 10F to Form 41 Migration, and Five Transitional DTAA Questions the ITA 2025 Has Left Unanswered

1. The Problem – A Silent Transitional Question With Rs. 50,000 Crore in Treaty Benefits at Stake

On 1 April 2026, the Income-tax Act, 1961 stood repealed by Section 536(1) of the Income-tax Act, 2025. With 536 sections, 16 schedules, and a comprehensive savings architecture under Section 536(2), the new Act was designed to ensure seamless transition. For most domestic provisions — assessment procedures, TDS mechanics, penalty frameworks, appellate pathways—the transition has been mapped by the CBDT FAQ of 25 April 2026 and by dozens of practitioner guides. One critical dimension of the transition, however, has received virtually no analytical attention – the fate of the notifications issued under Section 90(1) of the 1961 Act that gave domestic legal force to India’s 90-plus Double Taxation Avoidance Agreements.

Section 90(1) of the 1961 Act empowered the Central Government to enter into agreements with foreign countries and to give effect to such agreements ‘by notification in the Official Gazette.’ The Supreme Court in Assessing Officer (International Taxation) v. Nestle SA [2023] 155 taxmann.com 384 (SC)/[2024] 296 Taxman 580 (SC)/[2023] 458 ITR 756 (SC) held, in the context of MFN clauses, that such a notification is a mandatory condition precedent for a DTAA to operate in Indian domestic law—a treaty ratified at the international level but not notified under Section 90(1) has no domestic legal force. The ratio of Nestle SA, extended by the Sky High Quartet of ITAT rulings (Sky High Lxxix Leasing Co. Ltd. v. ACIT (IT) [2025] 179 taxmann.com 264 (Mumbai-Trib.) and companion rulings) to the MLI’s Principal Purpose Test, confirms that the notification mechanism is the statutory conduit through which international treaty law becomes operative in Indian tax administration.

Now that Section 90(1) of the 1961 Act has been replaced by Section 4(1) of the ITA 2025—a re-enactment with materially similar language but a different statutory home—the question is fundamental – do the 90-plus notifications issued under Section 90(1) of the 1961 Act automatically continue as notifications under Section 4(1) of the ITA 2025? Or does the repeal of the 1961 Act, even with the Section 536(2) savings clause, require fresh notifications under the new Act before India’s DTAAs are enforceable in domestic proceedings? This article addresses this question and five subsidiary transitional issues that flow from it.

2. Statutory Architecture—Section 90(1) of the 1961 Act vs Section 4(1) of the ITA 2025

Section 90(1) of the 1961 Act provided that the Central Government ‘may enter into an agreement with the Government of any country outside India or specified territory outside India for the granting of relief in respect of income on which have been paid both income-tax under this Act and income-tax in that country’ and, critically, may ‘by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.’ The notification mechanism was both the instrument by which a treaty entered Indian domestic law and the source of the Assessing Officer’s authority to apply treaty rates and exemptions.

Section 4(1) of the ITA 2025, titled ‘Agreements with foreign countries or specified territories,’ replicates this architecture. The Central Government ‘may enter into an agreement with the Government of any country outside India or specified territory’ and ‘may, by notification, make such provisions as may be necessary for implementing the agreement.’ The language is substantively identical. The critical structural question is whether the continuity of the ‘agreement’ (i.e., the DTAA itself, an international instrument) also carries the continuity of the domestic ‘notification’ issued under the prior statute’s implementation provision.

The answer turns on Section 536(2)(b) of the ITA 2025, which provides that ‘all rights, privileges, obligations, and liabilities acquired, accrued, or incurred under the repealed Act’ shall be preserved. The question is whether a DTAA notification issued under Section 90(1) of the 1961 Act created a ‘right’ or ‘privilege’ under the repealed Act that is preserved by Section 536(2)(b)—or whether the notification was merely a procedural instrument that dies with the repeal of its enabling provision.

3. The Nestle SA Principle – Why the Notification Question Matters

The Supreme Court in Assessing Officer (International Taxation) v. Nestle SA [2023] 155 taxmann.com 384 (SC)/[2024] 296 Taxman 580 (SC)/[2023] 458 ITR 756 (SC) held that a DTAA provision (specifically, an MFN clause in a protocol) cannot operate in Indian domestic tax proceedings unless a specific notification under Section 90(1) has been issued to give it domestic legal force. The ratio was stated in broad terms – treaty provisions become enforceable in India through the notification mechanism; the treaty itself – ratified at the executive level through deposit of instruments – does not automatically constitute a notification. As the Supreme Court noted, the notification under Section 90(1) is the ‘mandatory condition’ for domestic enforceability.

The Sky High Lxxix Leasing Co. Ltd. (supra) and connected rulings on Kosi Aviation, Sunflower Aircraft Leasing, and Sky High Appeal XLIII) extended this ratio to the MLI’s PPT – holding that the MLI, ratified in 2019 and effective from 1 October 2019, has no domestic legal force because no DTAA-specific notifications were issued incorporating the MLI modifications. The India’s Ratification Notification (S.O. 2887(E) dated 09.08.2019) merely recorded India’s ratification; it did not reconstitute each Covered Tax Agreement to embed the MLI modifications.

Applying this principle to the ITA 2025 transition – if the DTAA notification under the old Section 90(1) is not carried forward by Section 536(2)(b), then by strict application of the Nestle SA ratio, India’s DTAAs would require fresh notifications under Section 4(1) of the ITA 2025 before they are enforceable in domestic proceedings for Tax Year 2026-27 onwards. This is not merely theoretical – it is the logical extension of a principle the Supreme Court established in a closely analogous context, deployed by the same Revenue apparatus that will conduct Tax Year 2026-27 assessments.

Click Here To Read The Full Article

The post [Opinion] Do India’s 90-Plus DTAA Notifications Survive the ITA 2025 Repeal? appeared first on Taxmann Blog.

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Circular e.F.No.IFSCA-PLNP/94/2025-Capital Markets, Dated: 12.05.2026

The International Financial Services Centres Authority (IFSCA) has issued a clarification regarding the framework governing implementation services provided by Investment Advisers registered in IFSCs.

1. Meaning of Implementation Services

The circular clarifies that Implementation services include services relating to:

• Execution of investment advice, or
• Giving effect to investment advice rendered to clients

2. Permitted Channels for Providing Services

The framework specifies the permissible channels through which such services may be offered, depending on the nature of the financial product.

These channels include:

• Global Access Providers (GAPs)
• Regulated platforms
• Asset managers and other regulated entities

3. Objective of the Clarification

The clarification aims to:

• Provide regulatory clarity for IFSC-registered Investment Advisers
• Ensure proper execution framework for advisory services
• Promote transparent and compliant investment implementation mechanisms

4. Regulatory Significance

The framework helps:

• Distinguish advisory activities from execution-related functions
• Establish approved mechanisms for implementation of investment advice

5. Conclusion

The clarification strengthens the regulatory framework for Investment Advisers in IFSCs by defining implementation services and prescribing recognised channels for execution of investment advice in a compliant and structured manner.

Click Here To Read The Full Circular

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Case Details: Thermo Fisher Scientific India (P.) Ltd., In re [2026] 185 taxmann.com 608 (AAAR-ODISHA)

Judiciary and Counsel Details

• P. R. Lakra & Ms Yamini Sarangi, Member
• Hasti Shah, Manager Taxation, Ritesh Gyanchandani & Vikash Agarwal, Authorised Representatives for the Applicant.

Facts of the Case

The appellant, engaged in pan-India trading of analytical and laboratory equipment, provided repair and maintenance services in Odisha under Annual Maintenance Contracts (AMC) and Comprehensive Maintenance Contracts (CMC) to customers located in Odisha. All contracts, invoicing, inventory management, and administrative functions were carried out by the Head Office situated in Maharashtra, while Field Service Engineers (FSEs) were deployed in Odisha for on-site servicing and related activities. It sought a ruling on whether such operational presence constituted a ‘place of business’ or ‘fixed establishment’ in Odisha and whether it attracted liability for separate GST registration. The matter was accordingly placed before the Appellate Authority for Advance Ruling (AAAR).

AAAR Held

The AAAR held that the activities carried out in Odisha through FSEs did not amount to a ‘place of business’ or ‘fixed establishment’ under Section 2(85) and Section 2(50) of the CGST Act and Odisha GST Act, as there was no sufficient degree of permanence or independent operational setup in the state. It was observed that all contractual arrangements, invoicing, and supply decisions were undertaken and controlled from the Head Office in Maharashtra, and the mere deployment of employees along with temporary storage of tools and spare parts did not alter the location of supply. The Authority further held that since taxable supplies originated from Maharashtra, the conditions under Section 22 for obtaining separate registration in Odisha were not satisfied. Accordingly, the AAAR set aside the AAR ruling and held that no separate GST registration in Odisha was required.

List of Cases Referred to

• Thermo Fisher Scientific India (P.) Ltd., In re [2025] 177 taxmann.com 408 (AAR – ODISHA) (para 1)
• T & D Electricals, In re [2020] 120 taxmann.com 409/[2021] 83 GST 542/[2020] 33 GSTL 286 (AAR – RAJASTHAN) (para 4.9)
• Konkan Railway Corporation Ltd. In re [2022] 144 taxmann.com 29/[2023] 95 GST 93 (AAR – ODISHA) (para 4.9)
• Gandhar Oil Refinery (India) Ltd., In re [2019] 106 taxmann.com 291/76 GST 446/26 GSTL 531 (AAR – MAHARASHTRA) (para 4.11).

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