Bonus Shares - Careful when you sell !

ZERO tax has been the biggest advantage of long term equity investing in India. This particular advantage makes investing in any other asset class fall pale by comparison.

Shareholders in India get an exemption from paying tax on long term capital gains [gains on stocks held for more than 12 months] and pay short term capital gains [gains on stocks held for less than 12 months] at a rate of 15%, provided the stocks have been sold on a recognised stock exchange in India and STT has been paid on such transactions.

This post deals with the tax treatment of new shares issued through stock splits and bonus issues. One needs to understand the difference between the two and be careful at the time of selling to avoid any kind of tax tangle.

In recent times, a host of companies have split the face value of the shares, some have issued bonus shares to their shareholders and some companies have done both : a stock split and a bonus. Both these tools enhance liquidity of the shares in the market and provide the shareholders an option to partially exit their positions. At the same time, these actions come with certain disadvantages like: unnecessary hype around the bonus issue and gullible investors falling for the lure of  it. The net advantages of issuing bonus shares and share splits is debatable. Here, I will restrict myself to the tax treatment only.

Let's see what happens in the case of a stock split. In case of a stock split, the face value of the share is split into a lower value. For example, a share of face value of Rs 10 could be split into shares with face value of Rs 5 each or any other lower face value till Re 1. As per SEBI guidelines, the lowest face value that companies in India can have for their shares is Re1.
 

In case of a stock split, the original shares and the new shares issued by the company are considered to be acquired at the same time. Only the acquisition price of the shares [both original and new] reduces proportionately. Say for example, a share [Face value Rs 10] was bought on Jan 1' 2014 for Rs 100 per share. The company announces a stock split in the ratio 1:1 on March 1, 2015. Now,  a shareholder would have 2 shares in his account for every single share that he or she purchased. On March 1, 2015 the acquisition cost of the shares would be considered to be Rs 50 per share for the 2 shares. Lets assume that the price in the market post split is Rs 70 per share. While selling, the capital gains on both the shares would be considered long term capital gains and hence would be exempt from any tax since the holding period would have been more than 12 months.

Let's consider the same example for a bonus issue.

In case of a bonus issue, the original shares and the new shares issued by the company are treated differently under the taxation rules. Say for example, a share was bought on Jan 1' 2014 for Rs 100 per share. The company announces a bonus in the ratio 1:1 on March 1, 2015. Now,  a shareholder would have 2 shares in his account for every single share that he or she purchased. On March 1, 2015 the acquisition cost of the shares would be considered to be Rs 100 for the old share and Zero for the new bonus share. Lets assume that the price in the market post bonus is Rs 70 per share. On selling, the capital gains on the old share would be considered as long term capital gains and hence would be exempt from tax. But for the new shares issued as bonus, the acquisition date would be March 1, 2015 and the acquisition price would be Zero. If one happens to sell the new bonus share within 12 months of the acquisition date i.e. March 1, 2015 : the short term capital gains would apply on the entire selling price of Rs 70 since the bonus shares are considered to  have been acquired at zero cost.

If you enjoy the advantage of exemption from long term capital gains tax , have companies in your portfolio which have announced bonus issues and you are sitting on large capital gains: be careful while selling or you may find yourself tied in tax knots.

Reference :  http://tinyurl.com/qd3oweh