You can have the cake n eat it too..

How about getting bonus without having to pay up any tax on it? Sounds interesting. Wondering whether it can be possible? Perhaps, you have not heard of Bonus Stripping. What might sound, as Bonus extravaganza in layman’s term is “Bonus Stripping” under the taxman’s lenses.

Bonus stripping is buying of a financial asset like shares/mutual fund units on which bonus is declared before the record date of declaration of bonus to the investor and later selling the original quantity of financial asset bought, to book a loss for income tax purpose.

Legally you would be booking a loss whereas it’s a major gain. Quite legal of course, it can be called tax avoidance or deferring tax payments.

For instance lets say an individual buys 10,000 units of a fund at a Net Asset Value of Rs.10/- per unit for a total amount of Rs.1,00,000. Now, the individual, after bonus, would be having a total of 20,000 units and the NAV of the fund post bonus would approximately dropdown to Rs.5.50/- per unit. Which means his total amount would be Rs.1,10,000/- .On the sale of the original  10,000 units, the investor would be booking a loss i.e. a short term loss, as the mutual fund units are held for a period not exceeding one year.

Thus, for income tax purpose you will be

registering a short-term loss but financially you have made a gain.

Hence, to prevent the practice of bonus stripping, a new sub-section (8) is inserted in section 94. Under this sub-section, it is proposed to curb the practice of Bonus Stripping through issue of Bonus units by mutual funds.

Provisions of sec 94(8)

Sec 94 subsection 8 restricts setting off loss arising out of transfer of units if the following conditions are satisfied: -

v      Units are purchased within three months prior to the record date.

v      On such units, the purchaser is allotted or is entitled to additional units, in other words bonus units without payment.

v      Such units i.e. the original units are sold within a period of nine months after the record date.

v      The purchaser continues to hold the additional units, i.e. bonus units allotted.

Thus, the loss arising on sale of such original units is not to be considered at all while computing the taxable income of the purchaser, i.e. the loss if any will be ignored for computing the income chargeable to tax. However, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of the bonus units.

Let us take up few illustrations to understand it better:

Case-1

Here, Units are purchased within 3 months prior to record date and sold within 9 months after record date. All the conditions laid out by sec 94(8) are being satisfied, consequently the loss would not be allowed for set off.

Case-2

It is the same as case-1 and hence the provisions of Sec 94(8) would be applicable.

Case-3

Here, we notice that 1^st condition i.e purchase of units within 3 months prior to record date is not satisfied and hence, the provisions of sec 94(8) is not attracted.

Case-4

In this case we see that sale is taking place well after the elapsing of 9 months after the record date. Hence, sec 94(8) is not attracted.

The above analysis gives a good grip on the ramifications of the provisions of bonus stripping. An investor can plan out his investment scheme in a safe manner so that the provision of the said section becomes impotent.

“But its not over till the fat lady sings” That’s because the equities are not covered within the brackets of the said section, as the provision covers only mutual fund units and not equities.

When a corporate decides to issue bonus share the price of the share falls proportionately. When bonus is declared, the share prices of the company do rise if it meets the, market expectations. However, the prices may remain unaffected or even fall after a bonus is declared.

This concept can be well understood with    an example:

Here, the bonus is declared on the 2^nd, the investor buys 100 shares on 4^th at Rs.325/-.On 9^th the stock goes ex-bonus and thus the share price falls in the ratio 1:2. i.e. 2 bonus share received for 1 share held. Thus, now the share price is Rs.112/- exactly 1/3^rd of the price of the previous day Rs.336/-. Thus, now the investor sells the original shares i.e. 100 shares at a loss of Rs.213/- per share. Here, we see that the investor can get himself stripped of the capital gain of Rs.21,300/- by investing Rs.32,500/-  and not loosing anything in the process. Hence, an investor can safeguard himself from the provision of bonus stripping by investing in shares and claim the loss. In the above example, the investor can hold the bonus share for a year and earn long term capital gain, which is however exempted u/s 10(38) of the Income Tax Act.

The only concern here is that the investor has to tie himself with the bonus shares of the company for a year i.e to say that the company must be stable and has good long-term prospects. Tax Evasion is not the way to Wealth Creation, have a happy time investing. “Save and Earn rather than Evade and Earn”.

Word meanings:

v      Record Date: It is a date as may be fixed by a company/mutual fund/UTI for the purposes of entitlement to receive bonus (or income).

v      Units: A combination of multiple securities, such as common stock and warrants, sold together as a single product.

Quick Bites:

PAN Card is now mandatory to operate a demat account. Investors have to provide a copy of their PAN Card to their DP