At the time of the flotation of Irish Life I secured some shares in the company. I subsequently opted to take a scrip dividend rather than cash. Now the group has merged with Irish Permanent. What I want to know is how I calculate my capital gains tax liability in this situation.

Mr C.T., Dublin

Your question raises a number of interesting issues for the growing number of Irish shareholders, especially in an era where consolidation is leading to more and more stock mergers.

I gather that the initial shareholding in Irish Life contained both free and paid-for shares. The first point is that each of these is tackled in a different way for the purposes of capital gains tax, according to the Revenue Commissioners. Most regular readers of this column will be very familiar with the idea of capital gains tax by now but, for the benefit of those who are not, especially recent shareholders, let me briefly explain.

Practically every asset one acquires has a financial value at the time it is purchased or received. This value generally grows. If you dispose of the asset - shares, bonds, property other than the family home, etc. - you make a capital gain. That is the difference between the sale price and the purchase price.

Apart from the first £1,000 (€1,269.74) in any given tax year per individual, these gains are subject to capital gains tax. This is usually levied at 20 per cent, although it can be at a higher 40 per cent rate on certain property and certain foreign investments.

Free shares are considered to have a value of zero at the time they were received by you. Consequently, the capital gain on such shares upon disposal is the total value of the shares. What sets such shares apart from other shares you hold is that indexation to take account of inflation over the period for which you have held the shares does not apply in the case of free shares.

The shares you bought and paid for at the time of the flotation of Irish Life, on the other hand, do qualify for indexation. This indexation is worked out by multiplying the purchase or receipt price by an indexation factor prescribed by the Revenue Commissioners and deducting this sum from the sale price. The balance is subject to capital gains tax if it exceeds your tax-free threshold.

I say that is what happens in the normal course of events because, in a case like yours, the issue of scrip dividends corrupts the formula.

Basically a scrip dividend is a dividend which you receive from the company in which you are a shareholder by way of shares rather than cash. In the past, it was a considerably more tax efficient way to take dividends although that is less so nowadays.

The first thing you need to do with shares received by way of a scrip dividend is to assess their base price - the price at which the Revenue deems you to have received them. To do this, you need to add your scrip dividend shares to your other bought shares in Irish Life and then divide the result by the total you paid for your initial holding. For the purposes of this equation, discount any free shares you received upon flotation.

For example, suppose you bought 1,000 shares at a price of £1.50 (€1.91) per share and subsequently received 100 shares by way of scrip dividends. To calculate the base price of the scrip shares, tot up the total holding (1,000 + 100 = 1,100) and the price paid for the bought shares (1,000 x £1.50 = £1,500). Now divide the total price paid by the enlarged holding (1,500 divided by 1,100 = £1.36). This is now considered the base price for the shares you hold.

The next thing is to index those shares. The initial holding will be indexed from the new base price of £1.36 from the date of flotation - in the case of Irish Life, 1991. The scrip issues are also calculated from this base price but, given that you will have received a number of these shares each year by way of scrip dividend, you will have to index each batch of shares from the year in which you received them.

The next element you need to consider is how your holding was affected by the merger with Irish Permanent. Basically, as an Irish Life shareholder, your old shares were swapped for new ones in the merged group. This was done in the ratio of 60.85 per hundred. In other words, for every 100 old Irish Life shares you held, you now hold 60.85 shares in the new Irish Life & Permanent group.

Taking our example of the 1,100 Irish Life shares, including scrip issues, you should now hold 669 or 670 shares in the new group depending on how the group rounded the figures.

As I said before, the Revenue has a chart, which is publicly available, of the indexation factors for shares. It is usable for shares that have been held for more than 12 months and operates by cross-referencing the tax year in which the shares were bought and the year in which they are being sold. It works exactly like mileage charts on maps which show the mileage from, say, Dublin to Cork or Limerick to Belfast.

In the case of Irish Life, floated in 1991, the shares you bought after April 1st that year and sold, say, in February of this year would have an indexation factor of 1.161. That means you would take the purchase or base price - £1.36 after allowing for scrip issues in our case - and multiply it by 1.161, which rounds out to £1.58. This is the price you subtract from the current price to give you your capital gain. The indexation factors for the years since 1991/92, which you would need to calculate the capital gain on your scrip issues, are: 1.120 (1992/93); 1.099 (1993/94); 1.081 (1994/95); 1.054 (1995/96); 1.033 (1996/97); and 1.017 (1997/98). These all assume you sold the shares before the start of the 1999/2000 tax year.

One last complication in assessing your tax liability is the question of euros. Since January the prices of all shares traded on the Irish Stock Exchange have been quoted in euros, not pounds. For the purposes of your equation, you would need to transfer all your pound prices to euros (dividing by 0.787564) or all your euro prices to pounds (multiplying by 0.787564) to get a common currency for the purposes of calculating any liability.

Please remember that the prices mentioned in this reply are all illustrative. You will need to check at precisely what price you bought the initial tranche of Irish Life shares in order to ascertain the new post-scrip issue base price, which is the first step before factoring in the merger, indexation or euros.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 10-15 D'Olier Street, Dublin 2 or e-mail to dcoyle@irishtimes.ie. This column is a reader service and is not intended to replace professional advice. Due to the volume of mail, there may be a delay in answering queries. All suitable queries will be answered through the columns of the newspaper. No personal correspondence will be entered into.