Bonus shares offer big tax benefits

With big technology and pharma companies announcing bonus share issues, it's time to reveal a secret: Bonus shares can be effectively used a tax saving tool.

How is this done? Simply, the loss incurred after selling a stock once it turns ex-bonus can be used to set off against short term capital gains.

Bimal Doshi, Mumbai-based chartered accountant and management consultant, explains how shares of the company which announces bonus shares can be effectively used as a tool of tax planning.

As per the Income Tax Act, the cost of acquisition of bonus shares is taken at NIL, while cost of original shares remains at the cost at which there were purchased i.e. cum-bonus price. How effectively tax can be saved is explained by the following example.

 

When you pay tax
	Rs
Other income	1,50,000
STG*	2,00,000
Total income	3,50,000
Less deduction U/S 80CCC	10,000
Taxable income	3,40,000
Tax on taxable income	76,000
Less rebate @ 15% on 1,00,000	15,000
Net tax payable	61,000
*Short-term capital gains

Suppose short term capital gain realised by an individual is Rs 2,00,000. An individual also has other income amounting to Rs 1,50,000 on which deduction under Section 80l is not available.

Further assume that you have fully invested for all tax planning investments like 10,000 for 80CCC, Rs. 1.00.000 for section 88 etc.

In such case tax liability works out as follows:
Now suppose, the individual intends to by a stock which he will hold for a longer period. He may look for a scrip in which bonus is issued.

Take, for example, Infosys, which announced a bonus in the ratio of 3 shares for one held. If the investor buys Infosys shares, say at a cum-bonus price of Rs 5,400 per share.

The ex-price of the share will work out to Rs 1,350 share. The investor can sell the original shares purchased at the ex-bonus price and incur taxable short term capital loss, which he can set-off against his taxable STG.

Now suppose the investor buys 50 shares of Infosys at cum-bonus price of Rs 5,400 per share. He will receive 150 bonus shares on the original 50 shares at NIL cost.

The ex-bonus price will work out to Rs 1,350 per share. If the investor sells original 50 shares which he had purchased at Rs 5,400 per share at Rs 1,350 per share, thereby incurring total loss of Rs 2,02,500. Thus his tax liability shall work out as follows:

 

When you save tax
	Rs
Other income	1,50,000
STG*	2,00,000
Total income	3,50,000
Less loss on sale of Infosys stock#	2,00,000
Less deduction U/S 80CCC	10,000
Taxable income	1,40,000
Tax on taxable income	17,000
Less rebate @ 15% on 1,00,000	15,000
Net tax payable	2,000
*Short-term capital gains # Loss will be restricted to the extent of STG

Thus, effective tax outflow can be reduced to the extent of Rs 59,000. The investor will have 150 shares of Infosys at cost NIL value. He may hold the same for a period of one year and take advantage of the long term capital gain too.