Understanding Long-Term Capital Gains (LTCG) on the Sale of Bonus Shares

When dealing with investment strategies involving bonus shares, the concept of 'bonus stripping' often comes into play. This article delves into the intricacies of how long-term capital gains (LTCG) are calculated on the sale of bonus shares, including the advantages and recent amendments to the practice.

What is Bonus Stripping?

Bonus stripping is a financial strategy where an investor takes advantage of a company's bonus share issue program. It involves purchasing shares in a company before an announced bonus issue, holding them until the bonus shares are issued, and then selling both the original shares and the bonus shares for potential tax benefits.

The Stages of Bonus Stripping

Here are the key stages involved in bonus stripping:

Stage 1: Receiving News of an Upcoming Bonus Issue
Investors stay informed about companies planning to issue bonus shares to existing shareholders. Stage 2: Purchase
The investor buys shares of the company. Stage 3: Bonus Issue
According to the bonus issue ratio, the investor receives bonus shares. Stage 4: Short-Term Capital Loss and Sale
The original shares are sold at a lower price after the bonus issue, leading to a short-term capital loss. Stage 5: Long-Term Capital Gain
The bonus shares are sold after a year, resulting in a long-term capital gain.

Benefits of Bonus Stripping for the Investor

Bonus stripping offers several advantages to investors:

Average Tax Liability Reduction
The short-term capital loss (STCL) from the original shares can be offset against other capital gains (STCG and LTCG), reducing overall tax liability. Exemption and Tax Benefits
The long-term capital gain (LTCG) on the sale of bonus shares is partially exempt up to INR 1 Lakh and taxed at a rate of 10%. Enhanced Profit Margins
Investors can end up with higher profits while paying less tax on the transaction.

Section 948 Amended Provision

With the latest amendment in Section 948, certain practices related to bonus stripping have been modified:

Condition for Exemption
If an investor buys mutual fund units within 3 months prior to the record date of the bonus issue and sells all or any of the original shares within 9 months after the record date, the losses in such transactions are not considered for calculating capital gains. This means the loss cannot be claimed as a deduction, and the cost of the bonus shares is adjusted by the amount of the sold unit's price. Effective Date
The amended provision came into effect from April 1, 2023.

These changes aim to mitigate risks and streamline tax calculations, ensuring fair and transparent financial practices for all investors.

Conclusion

By understanding the complex yet strategic aspects of bonus stripping, investors can optimize their capital gains and minimize tax liabilities. However, it is crucial to stay informed about recent amendments and adhere to the prevailing tax regulations.

Key Takeaways:

Bonus stripping involves purchasing shares, receiving bonus shares, and then selling both for tax benefits. The short-term capital loss can offset other capital gains, and long-term capital gains on bonus shares may be partially exempted. New provisions in Section 948 further refine the rules surrounding bonus stripping, effective from the start of the 2023-24 fiscal year.