The tax treatment is different in each case As most
readers would know Reliance Power has announced a 3:5 bonus. What are
the implications of a bonus issue for investors? Does it indeed
increase their wealth? Is a bonus similar to a stock split? How about
the tax implications? Is there potential for tax planning? Today’s
article seeks to address these and related issues. Bonus sharesBonus
shares are nothing but shares issued free of cost to the shareholders
of a company. As this is essentially a book entry (reserves get
capitalised), the number of total shares increase following a bonus
issue, though the proportional ownership of shareholders does not
change. Also, post the bonus, the share price should fall in
proportion to the bonus issue, thereby making no difference to the
personal wealth of the shareholder. However, more often than not, a
bonus is perceived to be a strong signal given out by the company and
the consequent demand push for the shares causes the price to move up. As
far as tax is concerned, since no money is paid to acquire bonus
shares, these have to be valued at nil cost while making calculations
for capital gains. The originally acquired shares will continue to be
valued at the price paid at the time of acquisition. An incidental tax
planning benefit is that since the market price of the original shares
falls on account of the bonus, there may arise an opportunity to book a
notional loss on the original shares. Stock splitsStock
splits are a relatively new phenomenon in the Indian context. It is
important that investors understand the reasons that companies may
split their shares and how a stock split is different from a bonus
issue. In a stock split, the capital of the company remains the same,
whereas in a bonus issue, the capital increases and the reserves
decrease. However, in both actions (a stock split and a bonus) the net
worth of the company remains unaffected.A typical example is
a 2-for-1 stock split. Say a company announces a 2-for-1 stock split.
This means following the stock split, the company’s shares will start
trading at half the price from the previous day. Consequently, you will
own twice the number of shares you originally owned and the company, in
turn, will have twice the number of shares outstanding.
Consider the
case of Stock X below: The question that arises is, if there is
no difference to the wealth of the investor, then why does a company
announce a stock split? Well, the primary reason is to infuse
additional liquidity into the shares by making them more affordable. It
needs to be reiterated here that the shares only appear to be cheaper,
though it makes no difference whether you buy one share for Rs3,000 or
two for Rs1,500 each. As far as the tax implications for stock
splits are concerned, well, there isn’t any. A stock split, like a
bonus issue, is tax neutral. However, when the shares are sold, the
capital gains tax implications are different than those applicable to
bonus issues. Here, the original cost of the shares also has to be
reduced. For instance, in the above example, if the cost of the 100
shares at Rs150 per share was Rs 1,50,000, after the split the cost of
200 shares would be reduced to Rs75 per share, thereby keeping the
total cost constant at Rs1,50,000. Share buybacksA
share buyback is quite different from a bonus issue or a stock split.
Essar Oil, Reliance, Siemens and Infosys are some examples of companies
that have bought back their shares. A buyback is essentially a
financial tool in the hands of the corporate that affords flexibility
in the capital structure. A buyback allows the company to sustain a
higher debt-equity ratio. It is also a tool to defend against possible
takeovers. Generally, companies buyback their shares when they perceive
their own shares to be undervalued or when they have surplus cash for
which there is no ready capital investment need.Share buybacks
also prevent d