When Bonus Shares are Paid Out Under Dividend

When Bonus Shares are Paid Out Under Dividend

In India, bonus shares are issued as a reward to existing shareholders for their loyalty and investment in the company. This issuance can happen for various reasons such as capitalization of company reserves, increase in company's paid-up capital, or as a gesture of goodwill. It is essential to understand the tax implications of receiving bonus shares, especially in terms of income tax.

Understanding Bonus Shares

Bonus shares are issued at no cost to the shareholder, and they are allocated based on the number of shares already held by the shareholder. This means that if a shareholder holds 100 shares and the company declares a 1:1 bonus issue, the shareholder will receive an additional 100 shares without any additional payment. Essentially, the shareholder's ownership in the company increases, but the proportionate value of their investment remains the same.

Tax Implications of Bonus Shares

There are tax consequences when bonus shares are issued, especially concerning the Income Tax Act, 1961. The act governs the taxability of bonus shares received by a shareholder. When bonus shares are issued, the shareholders do not receive any income in the form of cash or money. Therefore, there is no immediate tax liability when bonus shares are allotted or issued.

However, the tax implications arise when the shareholder decides to sell the bonus shares. The cost of acquisition of the bonus shares is considered to be nil, as they were received without any additional payment. Hence, when the shareholder sells the bonus shares, the entire sale proceeds become taxable as capital gains.

Calculation of Capital Gains on Bonus Shares

The calculation of capital gains on bonus shares is done by considering the sale value of the shares minus the cost of acquisition. Since the cost of acquisition is considered to be nil, the entire sale proceeds become taxable as capital gains.

For example, if a shareholder receives 100 bonus shares and decides to sell them at Rs. 50 per share, the entire sale proceeds of Rs. 5,000 will be taxable as capital gains. However, if the shareholder sells the original shares that were held before the bonus issue, the cost of acquisition will be computed based on the purchase price of the original shares, and the capital gains will be calculated accordingly.

Dividend Distribution Tax (DDT)

Another aspect to consider when bonus shares are paid out under dividend is the dividend distribution tax (DDT). Companies pay DDT when they distribute dividends to their shareholders. However, when bonus shares are issued, no cash is paid out to the shareholders as dividends. Therefore, there is no dividend income generated, and hence no tax liability for the shareholder.

It is important to note that DDT is incurred by the company issuing the bonus shares and not by the shareholders receiving them. The company issuing the bonus shares is responsible for paying DDT on the value of the bonus shares that are issued. This helps in clarifying that bonus shares are a non-taxable event for the shareholders at the time of issue.

Tax Planning for Bonus Shares

Tax planning is essential for shareholders who receive bonus shares, especially concerning their future sale. Since the cost of acquisition of bonus shares is considered to be nil, the entire sale proceeds are taxable as capital gains. Shareholders need to consider this when selling their bonus shares and plan their tax liabilities accordingly.

One strategy for tax planning is to hold on to the bonus shares for the long term, as the capital gains tax rate is lower for long-term investments. By holding on to the bonus shares for more than 12 months, the shareholder can benefit from the lower long-term capital gains tax rate, which is currently at 20% (plus applicable surcharge and cess).

Furthermore, if the shareholder has the option to select which shares to sell, they can consider selling the original shares that were held before the bonus issue. This will allow them to calculate the capital gains based on the purchase price of the original shares, providing a lower tax liability compared to the sale of the bonus shares.

Conclusion

In conclusion, bonus shares are a common practice in India, and they have implications concerning income tax and dividend distribution tax. It is important for shareholders to understand the tax implications of receiving bonus shares, especially when it comes to the future sale of these shares. Tax planning is crucial to mitigate the tax liabilities associated with bonus shares, and shareholders should consider holding on to the bonus shares for the long term or strategically selecting which shares to sell to optimize their tax position. It is advisable for shareholders to seek professional tax advice to ensure compliance with Indian tax laws and make informed decisions regarding their bonus shares.