Bonus shares offer big tax benefits?

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Bonus shares offer big tax benefits

Nikhil Lohade & Nimesh Shah in Mumbai | April 15, 2004 10:10 IST

With big technology and pharma companies announcing bonus share
issues, it's time to reveal a secret: Bonus shares can be effectively
used a tax saving tool.

How is this done? Simply, the loss incurred after selling a stock once
it turns ex-bonus can be used to set off against short-term capital
gains.

Bimal Doshi, Mumbai-based chartered accountant and management
consultant, explains how shares of the company which announces bonus
shares can be effectively used as a tool of tax planning.

As per the Income Tax Act, the cost of acquisition of bonus shares is
taken at NIL, while cost of original shares remains at the cost at
which there were purchased i.e. cum-bonus price. How effectively tax
can be saved is explained by the following example.

Suppose short-term capital gain realised by an individual is Rs
200,000. An individual also has other income amounting to Rs 1,50,000
on which deduction under Section 80l is not available.

Further assume that you have  fully invested for all tax planning
investments like 10,000 for 80CCC, Rs 1.00.000 for section 88, etc.

In such case tax liability works out as follows:

Suppose, the individual intends to by a stock which he will hold for a
longer period. He may look for a scrip in which bonus is issued.

Take, for example, Infosys, which announced a bonus in the ratio of 3
shares for one held. If the investor buys Infosys shares, say at a
cum-bonus price of Rs 5,400 per share.

The ex-price of the share will work out to Rs 1,350 share. The
investor can sell the original shares purchased at the ex-bonus price
and incur taxable short-term capital loss, which he can set-off
against his taxable STG.

Now suppose the investor buys 50 shares of Infosys at cum-bonus price
of Rs 5,400 per share. He will receive 150 bonus shares on the
original 50 shares at NIL cost.

The ex-bonus price will work out to Rs 1,350 per share. If the
investor sells original 50 shares which he had purchased at Rs 5,400
per share at Rs 1,350 per share, thereby incurring total loss of Rs
2,02,500. Thus his tax liability shall work out as follows:

Thus, effective tax outflow can be reduced to the extent of Rs 59,000.
The investor will have 150 shares of Infosys at cost NIL value. He may
hold the same for a period of one year and take advantage of the
long-term capital gain too