If the change in tax rules for debt funds has been worrying you, the 1:1 bonus announced on Infosys shares could help reduce your tax liability. You can do this through a strategy called bonus stripping. If you buy Infosys shares now and sell half of your holding after the bonus date, the notional loss you incur can be adjusted against the gains from debt funds. "Selling the (original) shares soon after they become exbonus results in a short-term capital loss, which can be set off against any other taxable shortterm or long-term capital gains," says Vaibhav Sankla, director with tax consulting firm, H&R Block.
Savvy investors use the bonus stripping strategy to reduce their capital gains tax. Short-term gains from stocks, equity funds, debt funds, gold and property can be set off against the notional loss from the ex-bonus sale of shares.
Here's how bonus stripping works. Suppose you buy 100 shares of Infosys at the current market price of Rs 4,000 each. After the bonus date, the price of the scrip falls. Assuming that it falls 50% to Rs 2,000, you would have 200 shares of Infosys worth Rs 4 lakh. Now you sell the first 100 shares for Rs 2,000 each, incurring a notional loss of Rs 2 lakh from the sale. This is because under tax laws, the purchase price of the original 100 shares will be Rs 4,000 each. The acquisition price of the 100 bonus shares will be zero.
The loss from the sale can be adjusted against taxable short-term and long-term capital gains from other investments, including debt funds, gold and real estate. You can also adjust short-term gains from stocks and equity funds against this loss. If the loss cannot be fully adjusted, it can be carried forward for up to eight financial years. However, the interest earned on fixed deposits and bonds is not eligible for such adjustments.
How Infosys bonus can cut your capital gains tax
This could be a useful strategy for investors worried about the high tax they have to pay this year on their debt fund investments. The Budget upset their calculations by changing the tax rules for non-equity mutual funds. It extended the holding period for long-term capital gains from one year to three years. If an investor sells before three years, the gains are added to his income and taxed at the normal rate.
However, the bonus stripping strategy is a double-edged sword. The investor will have to hold the bonus shares for at least one year or pay tax. "Since the acquisition price of the bonus shares is considered zero, selling them before one year will attract 15% short-term capital gains tax," cautions Sudhir Kaushik, CFO and co-founder of Taxspanner.com. If you sell bonus shares before a year, the tax will be Rs 30,600, which will pare some of the gains from the bonus stripping. Also, keep in mind that this strategy will not work if you have had Infosys shares in your portfolio for more than a year. Tax laws follow the principle of first-in, first-out.
So, when you sell the shares after the bonus date, it will be deemed that you have sold the shares you already had in your portfolio. If those shares were bought more than a year ago, it would be treated as a long-term capital loss. Given that long-term capital gains from stocks and equity funds are taxfree, there is also no provision to adjust long-term capital losses from these instruments.