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Taxability of Bonus Shares Under Income Tax Act, 1961

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.

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 shares are issued to the shareholders in proportion of their current holdings. For example, the company may announce one bonus share for every share held by an investor. As the investor after bonus issue holds two shares (1 original share and 1 bonus share), 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 through Bonus Share

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.

Tax Calculation in case of Bonus Shares

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 us take an example to understand the calculation of capital gain tax in case of transfer of bonus shares.

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 would be as under –

Selling price (100*60) 6000
Cost of acquisition (100*50) (5000)
Capital gain on sale of original shares 1000

Short term capital gain tax of INR 150 (i.e. 15% of INR 1000) is payable.

Now, investor sells the rest 100 shares after some time (in same year) @ 70. Taxable short term capital gain on transfer of bonus share would be as under –

Selling price (100*70) 7000
Cost of acquisition (100*0) 0
Capital gain on sale of bonus shares 7000

Short term capital gain tax of INR 1050 (i.e. 15% of INR 7000) is payable.

It must be noted here that long term capital gain tax on transfer of shares would be payable @10% from Financial Year 2018-2019.

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

Categories: Income Tax

View Comments (7)

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

  • 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...

  • 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,

  • 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 (60x100 - 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 (100x70-100x0)=7000.

  • After bonus the price of shares of course come down and if I sale the original shares at loss and next year i sale my bonus shares. in this i have to pay tax as per you. first year i book loss and next year i to make payment of tax. pl. explain.

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