Bonus shares: no free lunches?

If there are two b-letter words that get investors all hyped up and frenzied, they are buybacks and bonus shares. 

In the case of buybacks, the investors wrongly imagine that the entire value of their shareholding has risen, even though only a miniscule portion may be eligible for the buyback and the hyped-up price may quickly correct back.

In the case of bonus, there is a perception that you are getting something for free. Even though the reasoning may well argue that there is nothing free; the emotions overrule and logic is swept aside.

Now let us look at bonus shares. Generally, upon issuance of bonus shares the market value reduces and the number of shares rises resulting in more or less the same total market value. Previously, the long term capital gains (LTCG) on shares were exempt. However, the Finance Act 2018 has removed this exemption and taxed the LTCG. Let us see how this will impact bonus shares.  

First we will look at the tax impact if bonus shares were issued prior to 31.01.2018 and next at the tax impact if bonus shares were issued after 31.01.2018. We will also look at the tax impact if no bonus shares were issued.

Prior to 31.01.2018, if you held the bonus shares for more than 1 year, they would be tax-exempt. But after 31.01.2018, the tax treatment has changed. Let us see how.

So as can be seen, bonus shares were not a very tax-efficient method of rewarding shareholders. Prior to 31.01.2018, the investor could atleast wait for a year and then sell his shares tax-free. However, after 31.01.2018, bonus shares have become even less tax friendly. Investors would well keep in mind that there are no free lunches. 

Notes:

1. The above calculation assumes there is no LTCG to set off against the LTCL.

2. LTCG below Rs. 1,00,000 is exempt.

3. Market value in case of no bonus shares is calculated by applying the bonus ratio.