What is Bonus Stripping and how I am using this strategy to cut taxes?
I had to sell my mutual funds and stocks to purchase real estate property this year. However, I was having a short term capital gain due to selling mutual funds and stocks. I am planning to cut taxes on short term capital gains using Bonus Stripping as one of the strategy. Do you know that you can save tax or cut taxes for short term capital gain by adopting a simple strategy which his legal? What is this bonus stripping in shares is all about? What are the features of Bonus Stripping and what are its limitations?
What is bonus stripping in shares?
Bonus stripping in shares is an option where an investor buys shares of a company which announced bonus shares and sell them off after bonus date and book notional loss. This notional loss can be legally adjusted against any other capital gains for the year and we can cut/save tax. This bonus stripping in company shares is still in practice u/s 94 (8) of Income Tax Act 1961.
Also Read: Best ELSS Mutual funds to invest in India now?
Bonus Strip explained with an example
Infosys announced a bonus issue few weeks back. Let us say Infy shares are quoting at Rs 4,000 (for easy explanation) per share and you purchased 100 shares @ Rs 4,000 costing Rs 4 Lakhs. Now on bonus date, shares of Infy would fall by 50% (1:1 bonus). Means the price would fall to Rs 2,000. However, you would get another 100 shares in your demat account. So you have a total of 200 shares, but the share price is Rs 2,000 per share. Total value of Rs 4 Lakhs remains same. However, if you sell 100 original shares out of this for Rs 2 Lakhs, it would indicate as notional loss of Rs 2 Lakhs (You brought 100 shares at Rs 4 Lakhs and sold 100 shares at Rs 2 Lakh). This notional loss can be adjusted against any other short term capital gain or long term capital gain from other sources. So, if you have capital gain of up to Rs 2 Lakhs from selling mutual funds or any other stocks, you can adjust this notional loss and you need not pay any short term capital gains tax.
Features of Bonus Stripping in shares
- You can legally sell such shares after ex-bonus date and adjust loss against any other capital gains. However, there are certain conditions to be fulfilled.
- Such notional loss can be adjusted against the short term capital gain or long term capital gain from stocks, equity funds, debt funds, gold and property.
- Unadjusted loss can be carried forward to 8 financial years.
- Good strategy for high tax bracket investors
- Good for those who are worrying about short term capital gains from debt funds as they would be treated as short term gains if sold within 3 years (as announced in recent budget this year).
What are the limitations of Bonus Stripping in shares?
- Investors have to hold bonus shares for at least 1 year to avoid such tax. Since the acquisition price of bonus shares is zero, if you sell them before 1 year, you need to pay 15% short term capital gain.
- Strategy does not work if you have shares for more than 1 year in your portfolio. Income tax law allows first in, first out principle. This is run on the principle that long term capital gain taxes are free after 1 year and loss of such investment, there is no provision to adjust.
- Investment in low quality stocks can wipe-off your capital itself.
- Strategy is not good during bear markets or when markets have reached and when stock markets are expected to see some correction.
- You can adjust such loss against any fixed deposit interest rate income in a year.
Bonus Stripping explained with various scenarios
Let us assume that Infy share is trading at Rs 4,000 and you bought 100 shares. Bonus is announced (1:1) and share price has fallen to Rs 2,000 on bonus date.
Scenario-1 – You have sold all shares (100 original and 100 bonus) within 1 year @ Rs 2,100
- Shares brought – Short term capital loss – (Rs 2,100 current rate – Rs 4,000 original price) x 100 shares = Loss of Rs 190,000
- Bonus shares sold within 1 year = Rs 2,100 current price – Rs 0 acquisition value of bonus shares x 100 bonus shares = Profit of Rs 210,000
- Short term capital gain = Rs 210,000 profit – Rs 190,000 of loss = Rs 20,000
- Short term capital gains tax = Rs 20,000 x 15% = Rs 3,000
Scenario-2 – Original shares sold within 1 year @ Rs 2,100 and bonus shares sold after 1 year from date of bonus issue
- Shares brought – Short term capital loss – (Rs 2,100 – Rs 4,000) x 100 = Loss of Rs 190,000
- Bonus shares sold after 1 year = Rs 2,100 – Rs 0 (bonus shares acquisition value is zero) x 100 = Profit of Rs 210,000. However, no capital gain as equity shares sold after 1 year are tax free
- Short term capital loss = Rs 190,000.
- This loss can be adjusted against other short term capital gains of stocks, mutual funds, gold or property. If you do not have any other capital gains, you can carry forward this to next 8 financial years and adjust them.
Also Read: What are the various ways employees can save income tax?
Conclusion: Bonus stripping is one of the best way to cut and save tax for short term or long term capital gain. However, this strategy should be used wisely to ensure that you do not end up making wrong steps. Buying blue chip stocks which announced a bonus issue would be better strategy. You should keep this mind that this strategy is legally valid only for the cases where bonus shares are sold after 1 year from the date of bonus shares allotment. Otherwise, you need to pay capital gains tax on bonus shares, where acquisition value is zero.
If you like this article, please share this on your Facebook or Twitter. This would be a special gift which you would be giving to our blog.
Suresh
What is Bonus Stripping and how I am using this strategy to cut taxes
- Why a Term Plan is the Best Insurance Option in India for Long-Term Financial Security? - December 12, 2024
- 5 Smart Strategies for Investing in NFOs - December 11, 2024
- 10.75% Sammaan Capital NCD Dec-2024 – Interest Rates, Risks & Investment Review - December 8, 2024
Great Article.
One doubt, You have explained unadjusted loss can be carry forwarded to next 8 years, How about unadjusted short term capital gain? can this also be adjusted against short term loss in next 8 years???
Please clarify
I have sold my Mutual Fund incurring short term capital gain. Please inform me whether under the present Income Tax Act there is any provision whereby I can save tax on this short term gain. Somebody informrd me that I may purchase shares of a company which is going to issue bonus shares and after receiving bonus shares I can sell my original shares within one month and can retain bonus shares, and thereby the loss incurred by selling original shares will be set off against short term capital gain. Is it correct?
Is there a deadline after which we can’t claim short-term capital loss by selling original shares in bonus issue? Read somewhere it is 1Apr 2015. Is it true?
Sir Its really Informative and I appreatiate your knowledge and the way you present with some real example.
Hatts of to you sir.
Dear Suresh
can we claim set off the income of fixed deposit (FD) of bank against loss due to stripping of bonus shares?
can any one clarify?
Today there is article in ECO regarding bonus stripping.
Reagrds
Tarachand
This is a great article. I was looking on for interest stripping on tax free funds when I came across this article about stock bonus stripping. I will soon sell my infy shares as you have suggested, to get the advantage.
I just wanted to confirm, if this notional loss can be adjusted against my bank fd interest also?
Suresh
Do we have same tax treatment for the income earned from Bank Fixed Deposit Interest?
T N SHAH
Suresh,
This is really very informative article. I must thank for this & also for other articles for gaining financial knowledge.
Regards
T N Shah
Thank you Tarachand. If you like our blog, pls give us facebook like
Hi suresh,
This is really helpful one. Do we have same tax treatment in case of stock splitting also? how stock splitting is treated
Suresh,
I have read couple of articles and very pleased with the way it has been presented. Appreciate your knowledge sharing.
Thanks
Thank you Muralikrishna. If you found our articles useful, you should recommend some of them to your friends who might belooking for similar analysis
Thanks for the Articles-Information shared on Recent-Current Investment Topics..
Please Notify me of new posts by email.
You can add yourself for email subscription which is available on home page. Don’t worry, I just added. You would get email confirmation, where you need to click and activiate email. Pls check your mail.
Suresh, I would like to Congratulate and Thank You for such a wondeful blog.
The articles are extremely informative, as well as articulated very flluidly and clearly.
Hi Suresh, I agree with Malligarjunan. Thanks so much for your efforts and sharing this with us.
Thank you Amit
I never knew such an option exists, thanks to you Suresh and congrats for the new house and stay blessed ๐
@ unadjusted loss can carried forward to 8 financial years i.e. we can file these loss in any year of ITR(in 8 year) ??/?
Thatz correct. Only unadjusted amount can be c/f
hey sir, I am 18 year old student and want to invest I stocks , I already buyed calsref 750 shares at 0.11each share price, which stocks I need to buy?I am need to stocks
Suresh,
It is really an informative article, we are learning a lot on market strategies through your portal. Thanks for sharing this.