A bonus issue, also called a bonus share issue or scrip issue, is a corporate action where a company distributes additional shares to its existing shareholders at no extra cost. These bonus shares are allocated in proportion to each shareholder’s current holdings. Unlike raising capital, the main aim of a bonus issue is to capitalize on the company’s reserves and surplus. By converting these reserves into share capital, the company boosts the number of outstanding shares without diluting the ownership percentage of existing shareholders.
What is Bonus Stripping?
When an investor buys shares of a company that is planning to announce issues of bonus shares and sells the original shares after receiving shares under the bonus issue, this practice is known as Bonus Stripping. Here are the stages of bonus stripping:
- The investor has news of a company set to issue bonus shares to existing shareholders.
- Hence, they buy shares of the said company.
- Under the bonus issue, the investor receives bonus shares as per the bonus issue ratio.
- Now, they sell the original shares after the bonus issue at the reduced share price after the bonus and thus incur a short-term capital loss.
- The investor sells the bonus shares after a year and thus earns a long-term capital gain.
Bonus Stripping was a common practice amongst investors to save taxes on capital gains income. However, under Budget 2022, the government made an amendment to Section 94(8) of the Income Tax Act to stop the practice of Bonus Stripping. The amended provision shall be applicable from 1st April 2023. As a result, bonus stripping would not be an option to evade taxes anymore.
Benefits of Bonus Stripping for the Investor
The investor gets the following benefits from bonus stripping:
- Taxpayers can set off the STCL incurred from the sale of original shares against other capital gains income, including both STCG and LTCG, resulting in a reduction of their tax liability.
- The LTCG on the sale of bonus shares is exempt up to INR 1 lac and taxable at a rate of 10%
- Out of the entire transaction, the investor ends up earning more profits and paying less tax on it
Example of Bonus Stripping
Mr. A came to know about the news of the bonus issue by Company XYZ. Mr. A buys 50 units of mutual funds at INR 1000 thus having invested INR 50,000. Under the bonus issue with a ratio of 1:1, the company issues 50 units to him as a bonus. Mr. A now holds 100 shares valuing INR 1,00,000. However, as a result of the bonus issue, the share price dropped to INR 500 thus he sold the original 50 shares. Further, In the next financial year, He sells the bonus 50 shares at the rate of INR 1200.
| Holdings | No. of Shares | Buy Price | Sale Price | Profit/Loss | Gain type |
| Original Shares | 50 | 50,000 | 25,000 | (25,000) | STCL |
| Bonus Shares | 50 | 0 | 60,000 | 60,000 | LTCG |
Hence, in this case, Mr. A took the following benefits:
- Earned Net Profit of INR 35,000 on the entire transaction.
- The STCL from the sale of original shares was set off against other capital gains, both STCG and LTCG.
- The LTCG of INR 60,000 is exempt from tax under Section 112A.
- Earned profits without paying taxes.
Budget Amendment – Section 94(8) of Income Tax Act
To avoid the practice of tax evasion using Bonus Stripping, the finance minister introduced an amendment to Section 94(8) under Budget 2022.
The existing Section 94(8) of the Income Tax Act kept a check on the bonus stripping transactions in the case of mutual fund units. Budget 2022, Section 94(8) further made amendment with effect from 1st April 2023, the word ‘units’ will be substituted by the word ‘securities and units’. Thus, this section now applies to both units of mutual funds and equity shares too.
As per Section 94(8), if:
- An investor buys mutual fund units within a period of 3 months prior to the record date of the bonus issue AND,
- The investor sells all or any of the original shares within a period of 9 months after the record date of the bonus issue
Then, any loss incurred on the above transaction shall be ignored to calculate capital gains. Thus, the investor will not be able to book the loss on such a sale transaction. Further, such loss would be considered as a purchase price for the bonus shares acquired.
In the above example, the STCL of INR 25,000 will be ignored for tax calculation. Mr. A will not be able to set off such a loss. Instead, INR 25,000 will be the cost of acquisition for the bonus shares.
Let us understand this amendment with another example
Nippon Mutual funds declare 1:1 bonus units on its units on 30th June 2023. The record date for the bonus units is 31st July 2023. The investor purchased 10,000 original units on 7th July 2023 at the rate of INR 50 per unit. Further, they sell 10,000 original units on 15th November 2023 at the rate of INR 35 per unit and 7,000 units on 20th November 2023 at the rate of INR 35 per unit.
Hence, in this case, section 94(8) will apply and the calculation of capital gains will be as below:
| Particulars | Original Units (10,000) | Bonus Units (7,000) |
| Sales value | 3,50,000 | 2,45,000 |
| Cost of Acquisition | 5,00,000 | 1,05,000 |
| Short-Term Capital Gain/Loss | (1,50,000) | 1,40,000 |
Note:
The cost of acquisition of bonus shares = 1,50,000 (STCL of original units) * 7,000 / 10,000 = 1,05,000.
Here, according to Section 94(8), the short-term loss of INR 1,50,000 will not be considered while calculating the total income of the investor. Further, such losses can not be set off or carried forward to future years.
FAQs
Bonus Stripping is the practice of buying shares of a company or units of a mutual fund to acquire bonus shares or units as a result of a bonus issue. The investor then sells the original shares or units to set off loss against other capital gains. Further, the investor sells bonus shares to earn long-term capital gains and pay tax at a reduced rate of 10%. This practice of earning profits from bonus issues but paying no tax or lower tax on it is bonus stripping.
Bonus Stripping is not legal in India. Section 94(8) of the Income Tax Act lays down conditions to check bonus stripping in the case of equity shares and units of mutual funds in India.
Budget 2022 amended Section 94(8) of the Income Tax Act, substituting the word ‘units’ with ‘securities and units’. Consequently, the restriction on Bonus Stripping for both equity shares and mutual fund units can now be applicable under Section 94(8). This amendment would come into effect from 1st April 2023.
Hey @kriti
A amendment to Section 94(8) of the Income Tax Act was enacted in Budget 2022. 'Securities and units' was changed for the phrase 'units.' As a result, Bonus Stripping can now be restricted in the case of both equity shares and mutual fund units under Section 94(8). This change would be effective from April 1, 2023.Hi @ShreyaSharma
The current provision of the sub section (8) of section 94 of the act contains anti- avoidance provisions to deal with bonus stripping transactions.As per Section 94(8), if:
such provisions of striping also apply to cash equity trades transactions for all kinds of corporate actions e.g. rights , bonus , dividend etc . ?
i have heard that i a trader/investor can take advantage of such stripping in profit loss gain adjustment if he has 2 demat accounts . e.g. on dividend record date ; sell the stock from the 1 demat and buy it from the other demat account !
is such kind of Shrewd practices still prevalent ?
@Sakshi_Shah1 can you help ?
Hey @HIREiN
As of now, there are restrictions on Bonus Stripping of shares and units of mutual funds as per Section 94(8) of Income Tax Act. Further, there are restrictions on Dividend Stripping of shares and units of mutual funds as per Section 94(7) of the Income Tax Act. A list of other actions has been mentioned under Section 94 of the Income Tax Act for the such restrictions have been introduced by the income tax department.
Hi @Yashvardhan_Agarwal
Hope this helps !!
Hi
As per Budget 2022, the loss resulting from bonus stripping of shares is now considered as cost of acquisition for the remaining bonus shares.
Further if the original shares are sold 9 months after the date of bonus, will the loss of these shares be allowed under the income tax act as the original shares are sold after 9 months and the provision says:
such person sells or transfers all or any of the 49a
[securities or] units referred to in clause (a) within
a period of nine months after such date, while continuing to hold all or any of the additional
49a
[securities or] units referred to in clause (b)
Hi
Would this section have impact on the currently running WIPRO buyback offer in which I am a long term shareholder and have bonus shares issued more than 5 years back?
Hi
Please reply to the above query. Thanks
Hi @gdshan,
The provisions of Bonus stripping apply when you purchase the shares within 3 months of announcement of bonus issue and sell within 9 months after the issue. In your stated case, the bonus issue was 5 years ago, this provision will not be applicable.
Hope this clarifies!