Thread by @FincademyIn

Complete Guide on Tax Planning in the Case of Bonus Shares

A Thread 🧵👇

1/ Bonus shares refers to the distribution of company’s reserves to the equity shareholders by giving them ‘extra’ shares on the basis of their previously held shares. Thus, giving bonus shares is a sign of positive financial status of a company.

2/ Advantage of Bonus for retail investor :-

Increase in the wealth of the retail investor

Before we go to this part, let me tell you a different story. ‘Two halves are more than one full’.

3/ You and your friend go to a restaurant. You both decide to order ‘one’ tomato soup. But then you decide to place an order for ‘two’ half tomato soups instead of ‘one’ full tomato soup.

4/ More often than not the quantity of two halves combined will be more than one full. This same psychological thing happens when a company declares the bonus.

5/ Say a company has a share price of ₹1000. It decides to give bonus shares in the ratio of 1:1. Thus, the investor with 100 shares will now have 200 shares. Logically speaking the share price must reduce to half at ₹500.

6/ However, the psychological thing comes into play. Thus, the stock price is adjusted to a little more than ₹500. Not just this, there will be more volume as the shares are trading at a lesser price. Hence, the shareholders would be rewarded.

7/ Taxation in Bonus

Before we go into the details, there are few basics which everyone needs to know:

(a) If the shares are held for more than 1 year, the gain arising shall be long term. Otherwise, it shall be considered as short term.

8/ (b) In case of long term capital gain on sale of shares on a recognized stock exchange where STT (Securities Transaction Tax) is paid, the gain shall be exempt to the extent of ₹1 lakh per annum.

9/ (c) However, if the gain in the above case is short term, then tax shall be levied at 15% of the gain.

(d) Shares are taxed on FIFO (First In First Out) basis. Simply speaking, the shares bought first shall be adjusted first while selling.

10/ Consider this example,

Here, the investor originally had 100 shares on 1st January 2018 bought at ₹150 per share. As the company announced bonus shares, the total shares doubled to ₹200.

11/ Now, whenever a company announces the bonus, the investor must sell half of the shares the next day the bonus is allotted. Selling them early would result into short term loss. The remaining half shares must be held for more than 1 year. This will make the gain as long term.

12/ In the table above, the investor did the same. He sold only 100 shares on 1st June 2018 at ₹75. The buying price on 1st January 2018 was ₹150. When the company announced the bonus the shares doubled but the share price was reduced to half.

13/ Now, as per FIFO, the 100 shares sold on 1st June 2018 at ₹75 will be assumed to be the shares bought first on 1st January 2018 at ₹150. This will result into short term capital loss of ₹75 per share. Therefore, the total short term loss shall be ₹7500.

14/ This loss can be adjusted against other short term capital gain and one can reduce the short term capital gain tax liability which otherwise would have been taxed at 15%.

15/ The remaining 100 shares must be sold after 1 year to turn them into long term and this will now help one in claiming exemption of ₹1 lakh.

Written by @caswapnilkabra

16/ That’s it, hope you like the thread.

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