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.
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.
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:
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.
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.
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|
|Total Number of Shares post bonus||200|
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