After taxing investors for dividend stripping, the Income Tax (I-T) Department is gearing up to tax bonus stripping. Official sources say scrutiny of returns filed by companies, brokers and individuals active in the stock markets and in possession of shares revealed wide use of this mechanism to evade tax.
According to data compiled by Business Standard Research Bureau, 314 companies have announced bonus shares since 2005-06. While assessments are on for 2008-09, in most cases the department is checking returns filed for the last four years under the scrutiny assessment, sources add.
To explain how bonus stripping works, a source said: “Say, someone is in possession of 1,000 shares of company XYZ, priced at Rs 1,000 each. Following a bonus issue announced by XYZ in the ratio of 1:1, the shareholder gets 1,000 stocks more for free. By the end of the issue, the investor owns 2,000 shares, each priced at Rs 500. He now sells the initial 1,000 shares at Rs 500 each, incurring a short-term capital loss. He uses the loss to reduce gains made in other market transactions. Later, he sells the remaining 1,000 shares, at a profit since they were acquired free and reaps the benefit of tax exemption on long-term capital gains.”
The I-T Department recommends an amendment to Section 94(8) of the Income Tax Act to bring such proceeds within the tax ambit.
While Section 94 of Indian Income Tax Act 1961 refers to tax avoidance by certain transactions in securities, Section 94(8) covers taxation of bonus shares held under the mutual fund units. Thus, bonus equity shares held by individual investors or companies are completely out of the tax net. The department now proposes to extend the coverage to securities, too, say sources.
Under Section 94(8), for tax purposes, the loss arising from the sale of shares held prior to the bonus issue is treated as the cost of acquisition for the bonus shares. If the amendment is made, the profit earned by the ordinary investor or the company will be subdued, since it has to be reduced from the loss incurred by selling the earlier lot which acts as the acquisition cost. At present, the profit has no upper limit, since there is no acquisition cost for bonus shares and, over and above this, there is exemption on long-term capital gains.
Taxation of dividend stripping was introduced in the Budget of 2002-03. Dividend stripping is purchasing of shares before a dividend is paid and later selling them when they go ex-dividend or, dividend payment does not apply to the shares after a certain date fixed by the company.
