Companies often announce bonus share issues, whereby you get a certain number of

additional shares for the shares that you already hold in the company. For instance, if a
company announces a bonus issue of 1:1 and if you were originally holding 100 shares,
you would get another 100 shares after the bonus issue. The market price of each share
would generally fall in line with the bonus issue ratio, so that the overall market price of
your total shareholding remains more or less the same (though of course, in many cases,
the markets react positively to a bonus issue, whereby the ex-bonus price of the share is
higher than the cum-bonus price as adjusted for the bonus issue).

Also Read | Gautam Nayak’s earlier columns

Commercially, from the investor’s point of view (though not from an issuing company’s
perspective), a stock or share split (share sub-division, to give it its proper legal name) is
quite similar. If you are holding 100 shares of a company with a face value of Rs. 10 each
and the company decides to split the shares into a face value of Rs. 5 each, after the split,
you would be holding 200 shares of Rs. 5 each instead of 100 shares with a face value of
Rs. 10 each. Here, too, normally the market price would adjust for the split and the
overall value of your total holding would remain in the same range.

In fact, in some countries where shares have no face value, there is really no difference
between a bonus issue and a stock split as it is just an increase in the number of shares.
When it comes to taxation in India, the two transactions are treated quite differently. Of
course, there is no tax at the time of the actual bonus issue or the actual share sub-
division. When it comes to sale of shares, the difference in tax treatment clearly comes to
light.

As far as bonus shares are concerned, the date of bonus issue is taken as the date of
acquisition and the cost is to be taken as nil. Therefore, to get exemption on sale of bonus
shares on the stock exchange, one should sell such bonus shares after at least 12 months
of the bonus issue. If the original shares are sold after the bonus issue within 12 months
after they have been purchased, one can claim a short-term capital loss on sale of such
shares since the market price would generally be lower than the original cost on account
of the bonus issue dilution.

If both the original shares and bonus shares are sold together and all the shares have been
held for less than 12 months, the loss on the original shares would be offset against the
gains on the bonus shares and would, therefore, be tax neutral. However, if both original
and bonus shares are sold together within 12 months of the bonus issue and the original
shares have been held for at least 12 months, you would end up paying tax on gains on
sale of bonus shares, while the loss on original shares would not be available for set off,
being exempt from tax. You would, therefore, end up paying tax on gains higher than the
actual gains earned by you.

So, one needs to take care not to sell bonus shares within 12 months from the date of the
bonus issue. There is also a tax advantage in the form of a short-term loss if you sell the
original shares acquired a few months before, soon after the bonus issue, and sell the
bonus shares only a year after the bonus issue. Of course, for the purpose of this
determination, when you are selling a part of your total shareholding, the shares acquired
earlier are to be regarded as having been sold first.

The tax position is quite different for sub-divided or split shares. All the shares are
regarded as having been acquired when the original shares were acquired and the cost of
the split shares is to be taken proportionate to the cost of the original shares. Unlike
bonus shares, which are regarded as new shares separate from the original shares, the
split shares are regarded as identical to the original shares, but with proportionate cost
adjustment. Therefore, if you have held the original shares for at least 12 months, but sell
the split shares within a few days of the stock split, the gains that you make would still be
regarded as long term and would qualify for tax exemption.

One wonders on the need for such differential tax treatment for two different modes of
corporate action, which are commercially the same for an investor. Surprisingly, there
would be no change in this differential tax treatment even under the Direct Taxes Code
Bill, 2010, which is supposed to simplify and rationalize the existing tax law.

Bonus shares is one of the few tax planning mechanisms to set-off a short term capital
gain without in effect theoretically incurring a loss. The pros call it Bonus stripping.

STCG can be very taxing @ about 34% (except of course listed shares sold in a
recognised SE). This can happen for instance with sale of shares in an unlisted company
within 12 months of allotment. The only way I could find to set this gains off was
through short term capital loss without incurring one (generally speaking).

Here is how it works (as also mentioned in the article):

Let us say I have 100 shares acquired at say Rs 50 just a few months before Bonus is
announced. If the company issues a 1:2 bonus then I will get 50 additional shares as on
the specified date. The cost of acquisition of the new shares is 0. Soon after the bonus is
announced the price will usually adjust to the same value pre-bonus, thus settling at about
Rs 33. The first 100 shares which are in queue when sold on a FIFO basis (assuming no
other shares of the security are held) can now be sold at Rs 33, incurring a loss of Rs 17
per share. This loss of say Rs 1700 can be set-off against the STCG. Note that the balance
50 shares have to be held for a minimum of a year because selling them in less than 1
year will necessarily incur STCG and the losses will get reversed. After a year they can
be sold with no tax implications LTCG being exempt from tax. Earlier LTCG was not
exempt from tax and hence the only benefit was the tax rate difference between STCG
and LTCG, but this changed after LTCG tax rate became nil!

There is a big risk however. You need to pray that the bonus shares held by you holds its
value till you sell. It may or may not. For instance in the above example if the 50 shares
held gets to be sold at say Rs 10, then you have sold all your shares for Rs 3800 and have
saved taxes of Rs 578 (34% of Rs 1700). So nett you incur a loss of Rs 622, not to
mention the opportunity costs of locked up capital. I know folks who are still waiting for
such lost value to recover trying to save on tax by Bonus stripping in Siemens (about
2000 pre- 1:1 bonus and 760 now, Unitech (about 480 pre 1:1 bonus and 88 now) among
others.