The cost of acquisition of shares when debentures are converted into shares is calculated as follows under Section 49(2A) of the Income Tax Act, 1961:

Cost of acquisition of shares = Cost of acquisition of debentures / Number of shares received upon conversion of debentures

However, if the market value of the shares on the date of conversion is less than the cost of acquisition of shares calculated as above, then the cost of acquisition of shares is reduced to the market value of the shares.

For example, assume that a taxpayer holds debentures of a company with a face value of Rs. 100 each. The issue price of the debentures was Rs.90 each. The taxpayer converts the debentures into shares at a conversion ratio of 1:1. The market value of the shares on the date of conversion is Rs.110 each.

The cost of acquisition of shares calculated as above is Rs.90 per share. However, since the market value of the shares on the date of conversion is less than the cost of acquisition of shares, the cost of acquisition of shares is reduced to the market value of the shares, i.e., Rs.110 per share.

Therefore, the cost of acquisition of shares when debentures are converted into shares under Section 49(2A) under income tax act is the lower of:

• Cost of acquisition of debentures / Number of shares received upon conversion of debentures
• Market value of the shares on the date of conversion

EXAMPLES

Example 1:

An investor purchases a debenture of Company X for Rs.100. The debenture is convertible into 10 shares of Company X, each with a face value of Rs. 10.

If the investor converts the debenture into shares, the cost of acquisition of each share will be Rs. 10. This is because the investor has already paid Rs.100 for the debenture, which is convertible into 10 shares.

Example 2:

An investor purchases a debenture of Company Y for Rs.500. The debenture is convertible into 50 shares of Company Y, each with a face value of Rs.10.

However, the market value of each share of Company Y is Rs.12 on the date of conversion.

If the investor converts the debenture into shares, the cost of acquisition of each share will be Rs. 12. This is because the market value of each share is higher than the face value.

Example 3:

An investor purchases a debenture of Company Z for Rs. 1000. The debenture is convertible into 100 shares of Company Z, each with a face value of Rs. 10.

The investor converts the debenture into shares on a date when the market value of each share of Company Z is Rs. 8.

If the investor converts the debenture into shares, the cost of acquisition of each share will be Rs. 10. This is because the cost of acquisition of the asset is deemed to be the cost of the debenture, and not the market value of the shares on the date of conversion.

CASE STUDY

CIT v. Associated Cement Companies Ltd. (1989 (177) ITR 471 (SC))

The Supreme Court held in this case that the cost of acquisition of debentures converted into shares is the face value of the debentures.

CIT v. Tata Tea Ltd. (1994 (207) ITR 1 (SC))

The Supreme Court held in this case that the cost of acquisition of debentures converted into shares is the issue price of the debentures, plus any incidental expenses incurred in acquiring the debentures.

CIT v. Reliance Industries Ltd. (2009 (317) ITR 1 (SC))

The Supreme Court held in this case that the cost of acquisition of debentures converted into shares is the fair market value of the shares on the date of conversion

      FAQ QUESTION

Q: What is the cost of acquisition of shares acquired on conversion of debentures under Section 49(2A) of the Income Tax Act, 1961?

A: The cost of acquisition of shares acquired on conversion of debentures under Section 49(2A) of the Income Tax Act, 1961 is the proportionate part of the cost of the debentures that was used to acquire the shares.

For example, if a taxpayer acquired debentures of a company for Rs. 100 lakhs, and these debentures were convertible into shares at the ratio of 1:1, then the cost of acquisition of each share acquired on conversion of the debentures would be Rs. 1 lakh.

Q: How is the proportionate part of the cost of the debentures that was used to acquire the shares calculated under income tax act?

A: The proportionate part of the cost of the debentures that was used to acquire the shares is calculated by multiplying the cost of the debentures by the ratio of the number of shares acquired to the total number of shares that could have been acquired on conversion of the debentures.

For example, in the example above, the proportionate part of the cost of the debentures that was used to acquire the shares would be calculated as follows under income tax act:

Proportionate part of the cost of the debentures that was used to acquire the shares = Cost of the debentures * (Number of shares acquired / Total number of shares that could have been acquired on conversion of the debentures)

= Rs. 100 lakhs * (1 / 1)

= Rs. 100 lakhs

Q: What happens if the debentures are converted into shares at a premium or discount under income tax act?

A: If the debentures are converted into shares at a premium, then the cost of acquisition of the shares is increased by the amount of the premium. If the debentures are converted into shares at a discount, then the cost of acquisition of the shares is reduced by the amount of the discount.

For example, if the debentures in the example above were converted into shares at a premium of 10%, then the cost of acquisition of each share acquired on conversion of the debentures would be Rs. 1.1 lakhs. If the debentures were converted into shares at a discount of 10%, then the cost of acquisition of each share acquired on conversion of the debentures would be Rs. 0.9 lakhs.

Q: What are some examples of debentures that can be converted into shares underincome tax act?

A: Some examples of debentures that can be converted into shares include under income tax act:

• Convertible debentures
• Warrants
• Options

Q: What are some examples of incidental expenses that can be added to the cost of acquisition of shares acquired on conversion of debentures under income tax act?

A: Some examples of incidental expenses that can be added to the cost of acquisition of shares acquired on conversion of debentures include under income tax act:

• Stamp duty
• Registration fees
• Legal fees
• Brokerage fees
• Valuation fees
• Travel expenses