What is Bonus Shares? When the additional shares are allotted to the existing shareholders without receiving any additional payment from them, it is known as issue of bonus shares. These shares are issued in certain proportion. Example 1:2 Bonus shares are allotted by capitalizing the reserves and surplus. Issue of bonus shares results in the conversion of the company's profits into share capital. Therefore it is termed as “Capitalization of Company's Profits.” It does not affect the Total Capital Structure of the Company.

Before Bonus issue After Bonus issue of 1:2 Liabilities Rs. Assets Equity Share Capital (1lakh shares of 10FV) 1000000 Fixed Assets 1600000 General Reserve 1500000 Current Assets 900000 2500000 After Bonus issue of 1:2 Liabilities Rs. Assets Equity Share Capital (1.5lakh shares of 10FV) 1500000 Fixed Assets 1600000 General Reserve 1000000 Current Assets 900000 2500000

Reasons for Issuing Bonus Shares The bonus issue tends to bring the market price per share within a more reasonable range. It increases the number of outstanding shares. This promotes more active trading. Share capital base increases and the company may achieve a more spectacular size in the eyes of the investing company. Shareholders regard a bonus issue as a strong indication that the prospects of the company have brightened and they can reasonably look for an increase in total dividend. It improves the prospects of raising additional funds in Future.

Key Terms Scrip Dividend Declaration Date: It is the date on which the announcement is made of new Dividend/Bonus Shares. Record Date: It is a particular date fixed by company on which all share holders , whose name is appear in the Register of Members will get Bonus shares/Dividend EX-Bonus Date: It is the date on which stock begins to trade without the right to receive the dividend declared.

Bonus Stripping It is a tool to bring down your Tax Liabilities. HOW?

Bonus stripping-way to save tax In bonus stripping, investors buy shares of companies which have announced bonus issues, and subsequently, sell the original holding at a loss once the stock becomes ex-bonus. This loss can be adjusted against their capital gains on other holdings. When bonus shares are sold, the cost of such shares will be considered to be nil. If such bonus shares are held for more than 12 months and sold on a stock exchange, the capital gains are exempt from tax (subject to payment of securities transaction tax). If sold within the 12-month period, the capital gains are taxable at 15% (plus surcharge). The cost price of the original shares is not adjusted pursuant to the bonus issue.

Avoidance of Tax by Certain Transactions in Securities: As per Section 94(7) Where— any person buys or acquires any securities or unit within a period of three months prior to the record date; such person sells or transfers— such securities within a period of three months after such date; or such unit within a period of nine months after such date;] the dividend or income on such securities or unit received or receivable by such person is exempt, Then, the loss, if any, arising to him on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of dividend or income received or receivable on such securities or unit, shall be ignored for the purposes of computing his income chargeable to tax.

Example of Bonus Stripping Imagine you invest in Company A Rs 100000 (100 shares @ Rs 1000 per share) and It declares bonus in the ratio of a 1:1. After the record date you get 100 shares as bonus and thus you will have 200 shares. Since no money was paid for the bonus shares thus the total cost of investment remains Rs 1,00,000. However the average cost of per share now becomes Rs 1,00,000/ 200 shares = Rs 500 Per share. (For the sake of simplicity brokerage, Delivery Charges etc has not been considered in the example). We also assume that Ruling Market Price of the Share after Bonus issue is Rs 550. Herein the cost of the shares would be as follows a) Shares bought by you – first 100 shares – Rs 1000 per share b) Shares received as bonus – Cost is nil. So the following 2 scenarios could arise.

Scenario 1 All shares sold at Rs 550 within one year from date of purchase. This will not lead to any savings in tax. The calculation will be as follows:- a) On shares bought – Short term Capital loss (Rs 550 – Rs 1000) X 100 shares = Rs (45,000) b) On bonus shares – Short term Capital gain (Rs 550 – Rs Nil) X 100 shares = Rs 55,000/- c)  Net capital gain (a+b)  = Rs 10,000 d) Tax payable (c X 15%) = Rs 1500

Scenario 2 First 100 shares sold at Rs 550 within one year from date of purchase and rest 100 shares sold after 1 year from the date of allotment of bonus shares (please note that in case of bonus shares 1 year is calculated from the date of allotment and not purchase of original shares) This arrangement will lead to savings in tax. The calculation will be as follows. a) On shares bought – Short term Capital loss (Rs 550 – Rs 1000) X 100 shares = Rs (45,000) Since the bonus shares will be sold after 1 year, hence no tax would need to be paid on the same. This loss of Rs 45,000 can be set off against the other short term capital gains during the year. It thus leads to a saving of 15% of Rs 45,000 = Rs 6750 on the tax outgo front. Please note that this scheme works only if the bonus shares are held for a period of more than one year from the date of allotment.

Another Example "Say, someone is in possession of 1,000 shares of company XYZ, priced at Rs 1,000 each. Following a bonus issue announced by XYZ in the ratio of 1:1, the shareholder gets 1,000 stocks more for free. By the end of the issue, the investor owns 2,000 shares, each priced at Rs 500. He now sells the initial 1,000 shares at Rs 500 each, incurring a short-term capital loss. He uses the loss to reduce gains made in other market transactions. Later, he sells the remaining 1,000 shares, at a profit since they were acquired free and reaps the benefit of tax exemption on long-term capital gains."