A lot of investors use “bonus stripping” to reduce their capital gains tax on stocks. But after the recent budget amendments, bonus stripping won't be possible from this financial year.
But what is bonus stripping? A🧵👇
But what is bonus stripping? A🧵👇
Bonus stripping can be used only when a company announces bonus shares.
Step 1: An investor buys the shares of the company that’s about to issue a bonus.
Step 2: The investor sells the shares after the price drop after ex-bonus & books a loss. Since the sale is made after the record date, the investors will still receive their bonus shares.
Step 2: The investor sells the shares after the price drop after ex-bonus & books a loss. Since the sale is made after the record date, the investors will still receive their bonus shares.
The loss can be used to offset any capital gains. The investor can sell the shares 1-year & claim a lower tax rate on LTCG (long-term capital gains) since the cost of acquisition of bonus shares is considered 0.
This is how bonus stripping was used to reduce the tax outgo.
This is how bonus stripping was used to reduce the tax outgo.
Example.
Mr X purchases 100 shares of a company at Rs 1000. Total investment value Rs 1,00,000
Now the company issues a 1:1 bonus. So Mr X will receive 100 additional shares, but his total investment value is the same. So the price per share drops from Rs 1000 to Rs 500
Mr X purchases 100 shares of a company at Rs 1000. Total investment value Rs 1,00,000
Now the company issues a 1:1 bonus. So Mr X will receive 100 additional shares, but his total investment value is the same. So the price per share drops from Rs 1000 to Rs 500
He sells the original 100 shares for Rs. 500 per share, incurring a short-term capital loss of Rs. 50,000. But he still keeps the bonus units with himself.
In the next financial year, he sells these bonus units. Since he didn't pay for the bonus shares, the selling price is his long-term capital gain, and the loss which he recorded earlier can be used to reduce tax liability.
Section 94(8) rule prevents the bonus stripping for mutual funds units. Now the government has also included shares in this section.
As per Budget 2022, under Section 94(8) of the Income Tax Act, the term ‘units’ shall be substituted by the term ‘securities or units’.
As per Budget 2022, under Section 94(8) of the Income Tax Act, the term ‘units’ shall be substituted by the term ‘securities or units’.
The Sec 94(8) rule
The losses arising from such transactions will be ignored for the purpose of calculation of income for capital gain tax if:
1. Investors who buy the units within a period of 3 months prior to the record date (date on which bonus is allotted).
The losses arising from such transactions will be ignored for the purpose of calculation of income for capital gain tax if:
1. Investors who buy the units within a period of 3 months prior to the record date (date on which bonus is allotted).
2. If such investor sells or transfers all or any of the original units within the period of 9 months after the record date.
Instead, the loss amount will be considered as the cost of acquisition for bonus shares.
Instead, the loss amount will be considered as the cost of acquisition for bonus shares.
Put simply, investors will no longer be able to reduce their tax liability by offsetting the loss incurred on the sale of shares.
If the investor incurs such losses, then the amount of loss is considered as the cost of acquisition for bonus shares.
If the investor incurs such losses, then the amount of loss is considered as the cost of acquisition for bonus shares.
Check out the Varsity taxation module t learn more about tax implications when trading and investing.
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