As stock market investors, we are beneficiaries to various corporate actions like bonus shares, rights shares and stock splits. These corporate actions are accompanied by stock price movements in short and long run affecting capital gains whenever we sell shares. As there is an effect on capital gains, tax implication also changes if we sell shares prior to one year. Through this article, we will try to understand what effect stock splits have on taxes payable in case of capital gains.

What is Stock Split

Stock split is a corporate action to increase the number of outstanding shares by issuing more shares to existing shareholders. For example, in a 2 for 1 stock split, a new share is issued against every share held. This means if there were 10 lakh outstanding shares prior to the split, now there would be 20 lakh shares. There is no increase in the market capitalization of the company, hence post split, price of the stock decreases in reverse ratio of split. In the above case, stock price gets halved.

Motivation for Stock Split

Stock split is usually announced by management to reverse stock illiquidity because of higher stock price as compared to other companies in same sector. Stock price is high; hence there are fewer participants due of affordability issue leading to illiquidity.

Tax Implication in case of Stock splits

Stock splits bear similarity to bonus share but tax calculation is slightly different. In case of bonus shares, cost of acquisition is zero but in case of stock split, the cost of acquisition reduces in reverse ratio of split.

In other words, when new shares are received on account of stock split, total number of shares with the individual would increase but the total value of investment remains the same and the total value of investment should be divided into total number of shares available with the individual after stock split.

For example, if one holds 100 shares at the rate of Rs 200, total investment is Rs 20000. If the company announces 2 for 1 split, stock holder will have 200 shares. Hence after stock split acquisition cost per share would be Rs. 100 (Rs. 20000/200).

Now if investors sells the shares in the market at Rs 200 per share before one year, short term capital gain will be equal to 200 * (200 – 100) = 20000. Keep in mind, purchase price for calculation of short term capital gain should be Rs. 100 and not Rs. 200 as shown above. Short term capital gain tax will be calculated on Rs 20000.

It must be noted that short term capital gain tax rate is 15% and long term capital gain tax applicable for financial year 2018-2019 on transfer of shares would be 10% in terms of section 112A of the Income Tax Act, 1961.

Effect on Stock Price

Stock split normally results in stock price appreciation post the split. As the stock appears cheap now, there is a demand push from small and retail investors leading to price rise.  Another reason for price appreciation can be attributed to psychological feeling that stock is good now as its price was very high before split. Good performance is expected to continue post split too leading to price rise in short run.

Reverse Stock Split

There is another corporate action which is quite similar to stock split but is performed in reverse manner. Here we combine existing outstanding shares so as to reduce total number of shares in market. This is the reason it’s named as reverse stock split. Motivation for reverse stock split is opposite to stock split as here promoters want to increase the price of shares. Stocks may be trading at a very low price leading to conclusion that it’s a penny stock. Promoters try to remove this notion by announcing reverse stock splits.

Capital gains are calculated in similar way as it is done for stock split, but in this case number of outstanding shares reduces and the acquisition price increases in the same proportion as the reverse stock split.

Source: InvestmentYogi is one of the leading personal finance websites in India

More Under Income Tax

5 Comments

  1. Tejas says:

    @ NILLOOFER DUMASIA

    As per Grandfathering clause of the act
    A method of determining the Cost of Acquisition (COA) of such investments have been specifically laid down as per the COA of such investments shall be deemed to be the higher of:

    The actual COA of such investments; and
    The lower of-
    Fair Market Value (‘FMV’) of such investments; and
    the Full Value of Consideration received or accruing as a result of the transfer of the capital asset i.e. the Sale Price
    Further, the FMV would be the highest price quoted on the recognised stock exchange on 31 January 2018. In case there is no trading of the said asset in such stock exchange, the highest price on a day immediately preceding 31 January 2018 shall be considered to be the FMV. In effect, the taxpayer can claim the highest price quoted on the recognised stock exchange on 31 January 2018 as the COA and claim the deduction for the same.

    So here independent of the shares being spilt the fmv of share as on 31.1.2018 shall be taken as deemed cost for calculation.
    Spiltting of cost as on that date shall not be done because we have to see fmv of each share on the given date rather than considering events which occured after that.

    This is one point of view kindly let me know if there are any other views.

  2. NILLOOFER DUMASIA says:

    If the stock split in May 2019 as of HDFC Bank from Rs 2 to Rs 1 but FMV as on 31/01/2018 is for FV Rs 2. Should the FMV be also divide by half for grandfathering of cost. Please clarify

  3. Suyog says:

    This article has taken basic example, Let say u sold 100 share only and not all share @rs 200. Then cost of acquisition will be same as original price that Rs.200*100=20000 and Sell price will be same so no profit no loss. Then after 1 year or later date when u sold remaiining share @rs 200 *100=20000. Then capital gain will be 20k-10k(100*100)=10k.

  4. rugram says:

    Good article. Thanks. It would have been useful to clarify that in case a share after stock split is sold, the date of acquisition for capital gains would be the original date of purchase of the share before the stock split, and its acquisition price would be the purchase price after adjusting the stock split ratio as explained in the article.
    I would request the author to write a similar article on valuation of shares when a merger/demerger takes place, for purposes of Sec 49(2) of the Income-Tax Act. Many companies do not provide details on how the valuation should be done after a demerger takes place. Thanks in advance.

Leave a Comment

Your email address will not be published. Required fields are marked *

Search Posts by Date

June 2021
M T W T F S S
 123456
78910111213
14151617181920
21222324252627
282930