Did your shares from a particular company just increase without you purchasing any?
Congratulations! You might have been allotted some bonus shares.
Bonuses are always a delight, and in the world of investments, bonus shares are the equivalent of receiving an unexpected gift. You basically receive a bunch of shares for free!
What are bonus shares?
Bonus shares are new shares issued to existing shareholders without any additional expense. These bonus shares are typically distributed in proportion to your current holdings. They represent a company’s accrued earnings, which aren’t paid out as dividends but are transformed into additional shares. It can be considered a way in which a company rewards its stakeholders. This process is also known as a 'Bonus issue of shares’
What could be the advantages?
- For you, as an investor
- Provides additional shares for free and hence increases your investment
- When the dividend is announced, you receive a greater amount as you now have more shares
- It also is tax-beneficial, as dividends are taxable at 30% (on the higher side), whereas capital gains can be short-term at 15% and long-term at 10% (If exceeds ₹1 lakh)
- For the company
- It increases the liquidity of the company in the market as there are more shares available.
- The share price also reduces, making it affordable and attractive, especially for new investors.
How are bonus shares taxed?
There will be two transactions, once, when you receive the bonus shares and another when you sell such shares.
When you receive the bonus shares the cost price is considered to be zero and hence, you are not liable to pay any taxes on the same as there are no capital gains.
When the shares are sold, capital gains tax is levied on the sale of shares based on the FIFO(First in first out) method. As the bonus shares’ cost is considered zero, when bonus shares are sold, the entire selling price is considered capital gains.
Lets understand better with an example,
Say, Muskan was holding 200 shares of ABC Pvt. Ltd. that were purchased in Nov 2020 at a cost of ₹100 per share. The company announced a bonus issue of shares at a ratio of 2:1 in Jan 2022. This means that for every 2 shares, Muskan will receive 1 share for free. So, for 200 shares, she will receive an additional 100 shares, and the total number of shares held after the bonus will be 300.
Now what will be the tax implication if she sells 250 shares at a rate of ₹150 per share in Oct 2023?
As per the FIFO method, when the 250 shares are sold, firstly, the original shares will be sold, and then the bonus shares.
Since the shares are held for more than a year, LTCG at 10% will be levied on the capital gain. Assuming this is the only LTCG, which is also less than ₹1 lakh, it will be exempt u/s 112A.
Moreover, in both situations, i.e., before and after the bonus issue, the total investment remains the same (₹20,000). The price per share decreases from ₹100 to ₹67 after the bonus issue.
Hope this helps!