Selling bonus shares? Note the tax implications carefully
February, 09th 2015
Many companies are declaring bonus shares for their shareholders. While this is good news for them there is also a tax implication that can lead to a sudden change for the investor. If there is a sale of shares by individual the amount could get classified as a short term capital gains. This in turn would require paying tax. This tax outgo can be significant and hence the details related to the bonus shares should be considered to know the exact tax impact. Here is a closer look at the entire issue in detail.
Cost of bonus shares
Bonus shares are those shares which are given free of cost to the existing investor in a specific ratio. Thus the ratio can be something like 1:1 which means that the investor will receive 1 share as bonus for every existing share held. This will double the holding of the investor but it will lead to a price correction wherein the impact of this bonus issue would keep the total value of the holding at the same levels. The investor feels happy because they are getting a free share and while the price on the stock exchange corrects for this so called free impact. However there is a different impact on the tax front. For the purpose of the tax calculations the cost of a bonus shares would be considered as zero. The implication of this is that any amount that is earned at the time of the sale of the shares would be considered as capital gains since there is no cost involved in the purchase.
Time period of holding
The key issue is the time period of holding of the bonus shares because this will determine their classification into a short term capital gain or a long term capital gain. If the share is held for a period of less than 12 months then it becomes a short term capital gain while if the holding period is 12 months or more then it is a long term capital gains. The question here is the date from which the time period for the holding would start because the original shares could have been held for a long time period while the bonus shares would have been issued at a later date. In this case the income tax act clearly states that the time period for the holding should be calculated from the issue of the bonus shares and not from the date of the purchase of the original shares.
There can be a higher tax implication on this front because it could be that there are investors who have bought the shares in a company a long time ago but due to the bonus issue they find themselves in a position wherein a part of their holding suddenly is due to the bonus shares. Now if there is a need to sell these shares in the next one year then they could have a tax impact that arises due to the short term capital gains nature of the benefits that they have earned. The rate on these gains is 15 per cent but it could end up being a higher total amount that would have to be paid to the tax department. Here they would have to segregate their holdings and sale into long term capital gains for the original holdings plus a short term gain for the bonus shares and then make the tax payments accordingly. This is one impact that they should pay careful attention to as one is liable to make mistakes on this front.