Dividends are one of the most important sources of earning for long term investors who invest in stocks. Companies declare dividends in two forms i.e. cash dividend and stock dividend (Bonus shares). Cash dividends are tax free in the hands of investors as company declaring the dividend pays dividend distribution tax on it. There is less clarity regarding tax implication of bonus shares/stock dividends. In this article, we will discuss the tax treatment of bonus shares.


What are Bonus shares?

Bonus shares are new shares issued to existing shareholders of a company. These are issued to shareholders in proportion to their current holdings. For example, the company may announce one bonus share for every share held by an investor. As the investor now holds two shares, EPS gets halved. Hence bonus share do not affect total EPS of investor.

Bonus shares are considered free shares as their cost of acquisition is taken as zero, although they are not free in true sense.

Purpose of bonus shares

As mentioned above, bonus shares do not have any impact on total EPS. If total EPS doesn’t change, then the question arises – what’s the need of bonus shares? Bonus shares basically help in solving two purposes:

1.     Improving the liquidity of a share – Suppose company’s shares are quite illiquid. Reason for illiquidity can be many but we are not bothered about that right now. At this point of time, company announces 1:1 bonus share. Since number of shares gets doubled in the market, supply of shares increase, resulting in a downward pressure on the stock price. Now, as the stock is available at cheaper valuation, more buyers get interested in it and hence liquidity improves.

2.     Tax saving – In case of cash dividends, companies have to pay dividend distribution tax resulting in diminished return for investors. In case of bonus shares, no dividend distribution tax is levied. These are treated as normal shares and tax implication only arises in case of short term capital gains (holding period less than 12 months) in the hands of investor.

Tax Calculation

Cost of acquisition of bonus shares is taken as zero hence the capital gain on selling a bonus share is equal to its selling price.

Let’s take an example to understand the calculation of short term capital gain tax in case of bonus shares (Long term capital gain tax is zero).

No. of Shares held originally

100

Bonus Announcement

 1:1

Total Number of Shares post bonus

200

Purchase Price

50

 Total number of shares held post bonus is 200 and let’s say investor sells 100 shares @ 60 before one year. Taxable short term capital gain in this case will be 100*(60-50) = 1000. If the existing short term capital gain tax rate is 15%, tax liability will be 0.15*1000 = 150.

Now, investor sells the rest 100 shares after some time (in same year) @ 70. Taxable short term capital gain in this case will be 100*(70-0) = 7000. Note that the cost of acquisition of bonus share is taken as 0. Hence the tax liability for this case will be 0.15*7000 = 1050.

Recommendation

Because of higher tax implication in case of short term capital gains on bonus shares, it’s advisable to sell them post one year holding period. Tax liability becomes zero on long term capital gains provided it is sold through a stock exchange and Securities Transactions Tax is paid on this sale transaction.

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

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0 responses to “Taxability of Bonus Shares Under Income Tax Act, 1961”

  1. MG Kapoor says:

    I do not seem to agree with you. When you sell separately, cost of acquisition of original shares does not get averaged out as indicated in your example for the simple reason that the cost of acquisition of bonus shares remains zero. In your example the shareholder is paying tax on averaged cost. Thus he is paying more tax. In your example his income under the head Short Term Capital Gain on original 100 shares will be (60×100 – 100 x100) = -4000 (Short Term Capital Loss).

    In his second sale of bonus shares his incoke under the head Short Term Capital Gains is correctly worked by you as (100×70-100×0)=7000.

  2. Raju CV says:

    Iam NRI and my family lives in India in a rented house . Is the house rent I pay in India exempted under any provison of IT act ?
    Regards,

  3. Raju CV says:

    We got very much clear understanding on the Tax treatment on Bonus shares. I would like to know how the Tax treatment on share split.
    Regards…

  4. Tiru says:

    Its a very good article. Tax implications of bonus shares is explained so well in the article. Keep it up

  5. rugram says:

    All that this article says is that if you sell a share within one year of its purchase (or allotment, in the case of bonus shares), the entire amount of capital gain is taxable as a short term capital gain. Therefore, it is better to sell a share after holding it for at least one year (to qualify it as a long term holding), provided it is sold through a stock exchange and Securities Transactions Tax is paid on this sale transaction. (The requirement about selling through a stock exchange is important but has not been mentioned.)

  6. agarwal shyam says:

    We welcome your views. Please forward my opinion that the face value of the s Year hares must not be different ,it may be rs.1 or rs.10. Sebi or ROC should do to fix the face value same for every Company and not 2 or 5 or 100. Because it is confusing to a common shareholder.

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