In bonus stripping, investors buy units within a period of three months  prior to record date, so by virtue of the their holding they receive additional unit as bonus without any cost and subsequently, sell the original holding at a loss once the stock becomes ex-bonus. This loss can be adjusted against their capital gains on other holdings. To curb this practice Section 94(8) came into picture.

According to the said section if an investors sells or transfers all or any of the units(original units)  within a period of nine months after record date (date on which bonus is alloted), while continuing to hold all or any of the additional (bonus unit), Then the loss if any arising from such transfer shall be ignored for the purpose of calculating income chargeable to tax and the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of additional units (bonus unit). We must know the Bonus Shares and its impact on taxability of Individual

Extract Of Section 94(8):

Where—

(a) any person buys or acquires any units within a period of three months prior to the record date;

(b) such person is allotted additional units without any payment on the basis of holding of such units on such date;

(c) such person sells or transfers all or any of the units referred to in clause (a) within a period of nine months after such date, while continuing to hold all or any of the additional units referred to in clause (b),

then, the loss, if any, arising to him on account of such purchase and sale of all or any of such units shall be ignored for the purposes of computing his income chargeable to tax and notwithstanding anything contained in any other provision of this Act, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such additional units referred to in clause (b) as are held by him on the date of such sale or transfer.

Explanation.—For the purposes of this section,—

(a) “interest” includes a dividend ;

(aa) “record date” means such date as may be fixed by—

(i) a company for the purposes of entitlement of the holder of the securities to receive dividend; or

(ii) a Mutual Fund or the Administrator of the specified undertaking or the specified company as referred to in the Explanation to clause (35) of section 10, for the purposes of entitlement of the holder of the units to receive income, or additional unit without any consideration, as the case may be;

(b) “securities” includes stocks and shares ;

(c) securities shall be deemed to be similar if they entitle their holders to the same rights against the same persons as to capital and interest and the same remedies for the enforcement of those rights, notwithstanding any difference in the total nominal amounts of the respective securities or in the form in which they are held or in the manner in which they can be transferred;

(d) “unit” shall have the meaning assigned to it in clause (b) of the Explanation to section 115AB.

Example of Bonus Stripping

Imagine you invest in Company A Rs 100000 (100 shares @ Rs 1000 per share) and It declares bonus in the ratio of a 1:1.

After the record date you get 100 shares as bonus and thus you will have 200 shares.

Since no money was paid for the bonus shares thus the total cost of investment remains Rs 1,00,000. However the average cost of per share now becomes Rs 1,00,000/ 200 shares = Rs 500 Per share. (For the sake of simplicity brokerage, Delivery Charges etc has not been considered in the example).

We also assume that Ruling Market Price of the Share after Bonus issue is Rs 550.

Herein the cost of the shares would be as follows

a) Shares bought by you – first 100 shares – Rs 1000 per share

b) Shares received as bonus – Cost is nil.

So the following 2 scenarios could arise.

Scenario 1 – All original shares sold at Rs 550 within 9 months of the record date

This will not lead to any savings in tax. The calculation will be as follows:-

a) On shares bought – Short term Capital loss (Rs 550 – Rs 1000) X 100 shares = Rs (45,000)- This loss shall be ignored for tax purpose and this amount shall be treated as cost of acquisition of the bonus share/units

Scenario 2 – First 100 shares sold at Rs 550 within one year from date of purchase and but after 9 months from the record date rest 100 shares sold after 1 year from the date of allotment of bonus shares (please note that in case of bonus shares 1 year is calculated from the date of allotment and not purchase of original shares)

This arrangement will lead to savings in tax. The calculation will be as follows.

a) On shares bought – Short term Capital loss (Rs 550 – Rs 1000) X 100 shares = Rs (45,000)

Since the bonus shares will be sold after 1 year, hence no tax would need to be paid on the same.

This loss of Rs 45,000s can be set off against the other short term capital gains during the year. It thus leads to a saving of 15% of Rs 45,000 = Rs 6750 on the tax outgo front.

Please note that this scheme works only if the bonus shares are held for a period of more than one year from the date of allotment.

However as per the newly inserted section 112A via Finance Act 2018, if the amount of long- term Capital gain exceeds Rs 1,00,000 than the amount in excess of Rs 1,00,000 shall be chargeable to tax @ 10% without indexation  (plus  heath and education cess and surcharge). However the application of sec 112A is subjected to certain conditions, one of it being the transfer should have taken place on or after 1stApril ,2018.

Extract Of Section 112A:

112A. (1) Notwithstanding anything contained in section 112, the tax payable by an assessee on his total income shall be determined in accordance with the provisions of sub-section (2), if—

 (i)  the total income includes any income chargeable under the head “Capital gains”;

(ii)  the capital gains arise from the transfer of a long-term capital asset being an equity share in a company or a unit of an equity oriented fund or a unit of a business trust;

(iii)  securities transaction tax under Chapter VII of the Finance (No. 2) Act, 2004 (23 of 2004) has,—

(a)  in a case where the long-term capital asset is in the nature of an equity share in a company, been paid on acquisition and transfer of such capital asset; or

(b) in a case where the long-term capital asset is in the nature of a unit of an equity oriented fund or a unit of a business trust, been paid on transfer of such capital asset.

(2) The tax payable by the assessee on the total income referred to in sub-section (1) shall be the aggregate of—

 (i)  the amount of income-tax calculated on such long-term capital gains exceeding one lakh rupees at the rate of ten per cent; and

(ii)  the amount of income-tax payable on the total income as reduced by the amount of long-term capital gains referred to in sub-section (1) as if the total income so reduced were the total income of the assessee:

Provided that in the case of an individual or a Hindu undivided family, being a resident, where the total income as reduced by such long-term capital gains is below the maximum amount which is not chargeable to income-tax, then, the long-term capital gains, for the purposes of clause (i), shall be reduced by the amount by which the total income as so reduced falls short of the maximum amount which is not chargeable to income-tax.

(3) The condition specified in clause (iii) of sub-section (1) shall not apply to a transfer undertaken on a recognised stock exchange located in any International Financial Services Centre and where the consideration for such transfer is received or receivable in foreign currency.

(4) The Central Government may, by notification in the Official Gazette, specify the nature of acquisition in respect of which the provisions of sub-clause (a) of clause (iii) of sub-section (1) shall not apply.

(5) Where the gross total income of an assessee includes any long-term capital gains referred to in sub-section (1), the deduction under Chapter VI-A shall be allowed from the gross total income as reduced by such capital gains.

(6) Where the total income of an assessee includes any long-term capital gains referred to in sub-section (1), the rebate under section 87A shall be allowed from the income-tax on the total income as reduced by tax payable on such capital gains.

(Republished With Amendments)

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7 responses to “Bonus stripping – Way to Save tax”

  1. Sam says:

    The Provision of Bonus Stripping under section 94(8)
    Applies to all units whether bought or acquired
    covers both open ended and close ended equity funds
    is applicable even in case where units are held as stock in trade
    is applicable only in respect of units and not shares
    does not apply if all additional units are transferred before the original units are sold.

  2. Kavi Kumud says:

    The article is updated on 4th Aug’18 but has missed to incorporate impact of taxability on long term capital gain as introduced in Budget 2018. Thus, article is misleading.

  3. Arun S. Sureka says:

    Dividend Stripping is covered by section 94(7) and it covers Shares & Unit Both. While Bonus Stripping is covered by Sec 94(8) and it covers only Units. Hence Shares are not covered by Bonus Stripping u/s 94(8).

  4. zalak thakker says:

    i want solution for one question .

    co. plans to give bonus share of 1 for 2 share of fair value of 10 as on 24-4-2012. post bonus the outstanding stock of co. will be entiteled to a dividend of 125% . sanjay wants to buyback 100 shres at prevailing price of 800 per share . if he sell his origional bought share after stock quotes ex bonus at 600 per share then what is capital gain / loss .

    Any help from u will be great.

  5. Anandan says:

    hello

    there is a typographical error in example
    it should be ( 100 shares @ Rs. 1000/- per share)

  6. CA DEV KUMAR KOTHARI says:

    In case of financial assets like bonus shares / securities S.55 (2) (iia) provides that cost of acquisition will be considered as nil. this is for the purposes of S. 48 and 49. This is not for S. 45 which is a charging section.
    Provision of S. 55(2) (iia) gives statutory recognition to the fact that cost of bonus shares/ units is nil. This is for clarity and ease to make computation of capital gains for original shares.
    Sale value minus nil will remain sale value or capital value. There is no element of gains. Furthermore when cost of acquisition is nil, there will be no change in allowable cost because ZERO will remain ZERO and there will not be higher deduction in respect to bonus shares or units in relation to those held for longer duration (say 20 years) in comparison to those held for short duration (say three years). Thus the capital gains will not be computed as per the computation provision. Hence the sale value of such assets may not be taxable.
    It is worth to note that where ever capital value is considered as taxable, specific provision has been provided in section 45 itself. For example, sub-sections (1A) , (3) ,(4) ,(5) of section 45 provides situations in which capital value or consideration accruing on transfer will be taxable irrespective of whether the asset has cost assessee any thing or not. The clause (ii) of the Explanation to S. 45 (5) specifically provide that in the situation covered by S.45(5) (b) the cost od acquisition and cost of improvement shall be taken to be nil.
    Therefore, it can be said that deemed cost of acquisition as nil doe not affect the charging section for capital gains that is section 45. where ever ‘capital value’ is to be taxed under head ‘capital gains’, specific provision is made in charging section that is S.45. S. 55 is limited to the purposes of S. 48 and 49 and and does not extend to S.45. Particularly so when application of such deemed cost of acquisition as nil goes against basic principal of taxation of ‘capital gains’ and not taxation of ‘capital value’.
    Thus as per principals, it can still be said that capital value of assets (sale value minus nil) is not ‘capital gains’ chargeable u/s 45 merely because in S. 55 statutory recognition is given to the fact that in acquisition of many assets the assessee had not incurred any cost of acquisition and /or cost of improvement.
    Zero is not amenable to increase by inflation index. It is never intention of legislature to compute capital gais or tax capital gains similarly irrespective of wider difference in period of holding. Even when there was no indexation of cost, the rate of tax or incidence of tax was lower in case of assets which were held for longer duration in comparison to those held for shorter period.

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