The Taxman Has An Eye On Your Bonus-Stripping Efforts

Bonus shares result in a feel-good effect for the investor but there is no change in the holding value in monetary terms because the traded price of the equity shares adjust for the additional shares given as bonus. Till some time ago, investors could try and set off losses from existing shareholdings against other capital gains, which is called bonus-stripping. However, Budget 2022 plugged that loophole as the bonus stripping provisions were extended to cover shares. Investors have to be careful while planning around a bonus issue so that the calculations do not result in a higher tax impact.

When a bonus share is issued, this comes free for the shareholder in the ratio declared by the company. For example, if an investor holds 500 shares and the bonus ratio is one for every one share held, then the investor will get an additional 500 shares and the total holding will become 1,000 shares after the bonus issue. However, the share price which was say Rs 100 before the issue will become half to reflect the new shares given and, hence, will become Rs 50. Assume that the initial shares were bought at Rs 70 by the investor. In such a case, the investor is now seeing a notional loss of Rs 20 on the initial shares. The new bonus shares were issued free of cost so there is a notional Rs 50 gain on the bonus shares. Overall though, the total value of the holding remains the same as this was 500 shares worth Rs 100 per share coming to a total of Rs 50,000 earlier; and then being 1,000 shares at Rs 50 each being Rs 50,000 later.

Investors earlier could buy the share before the bonus record date, book the loss on the original shares and then use this as a set-off against other capital gains that they would have made. The bonus shares would be held for more than a year and then sold reducing the tax on this too. This process is known as bonus stripping. One of the changes that was made in Budget 2022 was that shares were brought under the ambit of the Section 94(8) of the Income Tax Act that restricted bonus stripping. Earlier, this section just covered mutual fund units; but now even shares would be covered and, hence, investors would need to follow the guidelines here if they want their tax benefits post a bonus issue.

Section 94(8) of the Income Tax Act says that if shares or mutual fund units have been bought in a period of three months before the record date of the bonus and they have not been held for a period of nine months after the record date while continuing to hold part of or whole of the newly issued bonus shares, then the loss on the shares bought initially will not be allowed for the purpose of the tax calculations.

What this means is that if the investor has bought the original shares within three months of the bonus issue record date and sold it within nine months of the issue, then the investor will have to sell the entire amount of bonus shares to get the benefit of a loss on the original shares. The idea behind this move is that if the investor is forced to sell the bonus shares, then there will be a short term capital gains here (since cost of bonus shares are zero), which will be set off against the short-term capital loss on the original shares.

The other option for the investors is to hold the original shares for at least nine months from the record date and then sell the shares while continuing to hold the entire bonus units. But the risk increases in such a move in the sense that as time passes, the shares might behave in a manner that is different from the expectations which can impact the tax calculations. These provisions, already applicable for mutual funds, are now applicable for equity shares too and it is an effort to ensure that the investor is not just buying the shares to take the benefit of the adjustment in the price due to a bonus issue, leading to a loss of tax revenue.

The writer is founder, Moneyeduschool