Bonus shares are additional shares that a company issues to its existing shareholders at no extra cost. These shares are typically distributed in a certain ratio, like 1:1 or 2:1, which means you’d get one or two bonus shares for every share you already own.
Companies issue bonus shares for various reasons like rewarding their shareholders, enhancing liquidity, and reducing the share price, making it more accessible to potential investors.
For example, if you own 100 shares of a company, and it announces a 1:1 bonus issue, you’d receive an additional 100 shares for free. The total number of shares you own would double, although the market price per share will be halved to reflect the increase in shares, and hence your investment value remains the same.
How are bonus shares taxed?
See, there will be two transactions, one, when you receive the bonus shares and another when you sell such shares.
When you receive the bonus shares, you are not liable to pay any taxes as there are no capital gains.
When the shares are sold, capital gains tax is levied on the sale of shares. For the bonus shares, the cost of acquisition will be zero, and the date of purchase will be the day on which the bonus shares are issued.
Let’s take an example to understand better.
Say you’re holding 200 shares of ABC Pvt. Ltd., which you purchased in November 2020 at ₹100 per share. In August 2024, the company announced a 1:1 bonus issue, when the share price was ₹300. After the bonus, your total shares double to 400, and the share price adjusts to ₹150 per share.
Now, if you decide to sell 250 shares from your total holdings, as per FIFO (First in first out) settlement, your 200 original shares will be sold first and then the remaining 50 will be the bonus shares. Here’s how the capital gains will be calculated.
What is bonus stripping?
Bonus stripping is a tax-saving strategy that exploits the price adjustment that occurs when a company issues bonus shares.
It typically involves buying shares just before a company issues bonus shares and then selling the original shares at a lower (ex-bonus) price, resulting in a capital loss, which can then be set off against other capital gains, thereby reducing overall tax liability.
Example: Imagine you bought 200 shares of Company X at ₹100 per share. Shortly afterward, the company announces a 1:1 bonus issue, giving you 200 additional shares. The per-share price would then drop to ₹50, reflecting the bonus. If you sell the original 200 shares at this lower price, it creates a capital loss of ₹10,000, which can be used to offset other capital gains.
However, the Income Tax Act was amended in 2023 to curb this practice. Now, if an investor:
- acquires shares within three months before the record date of a bonus issue, and
- sells the original shares within nine months from the record date,
any resulting capital loss on the original shares will be disallowed for tax purposes in such a case.