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Tax escapades go the bonus stripping way
July, 16th 2007

Have bonus shares and save on capital gains tax. Or at least thats what a large number of investors seem to be resorting to these days. And the trend is only expected to continue with the rise in the number of companies rushing to dole out bonuses. Bonus stripping an act of buying shares at cum-bonus price and selling at exbonus price to book capital loss has been rampant over the past few years as companies have been on a bonus-issuing spree, say brokers.

So, how is bonus stripping done? Suppose an investor holds or buys shares at cum-bonus price (post announcement), which entitles him for free shares. He subsequently sells his original holdings at ex-bonus level, the price which is adjusted on the basis of the ratio. For instance, if the cum-bonus price is Rs 100 and the ratio is 1:1, the ex-bonus price will be Rs 50. By selling shares at ex-bonus price, investors book capital loss which can be set-off against gains made in other transactions, thereby availing the tax benefit. The ex-bonus date is followed by the record date which is fixed for reckoning the entitlement for bonus shares.

Investors have to sell shares only after the record date to ensure that they get free shares at the ratio fixed by the company.

In the above example, if an investor has 100 shares of X company, value of his investment will be Rs 10,000 at cum-bonus price. The ex-bonus price on the basis of 1:1 ratio works out to Rs 50, resulting in a fall in investment value to Rs 5,000. On sale of these shares, the investor books a capital loss of Rs 5, 000, which can be adjusted against the profit made on sale of other investments during that financial year. Bonus stripping in equity shares is not covered under any provision of Income Tax Act so far. Investors buying shares at cum-bonus price and selling ex-bonus will be eligible for claiming short-term capital loss on fall in value of shares post ex-bonus , said Bhupendra Shah, Mumbai-based tax professional.

Bonus stripping, however, is not advisable for short-term players. If an investor wants to sell bonus shares immediately after the allotment , he will be liable for short-term capital gains tax. Long-term investors, holding shares beyond one year, will be in a better position to gain from bonus stripping. There has been a sharp rise in bonus issues in the past few years, thanks to the significant improvement in corporate fundamentals and strengthening of reserves.

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