Reporting Bonus Shares and Rights Issue in Capital Gains

Investing in stocks often leads to the receipt of bonus shares or rights issues, which are common strategies used by companies to reward shareholders. However, understanding the tax implications of receiving bonus shares and participating in rights issues is crucial for both individual and institutional investors. The taxation of these financial instruments can vary significantly depending on various factors, including the holding period and the type of transaction.

Let us understand the taxation rules associated with bonus shares and rights issues, how they are reported in the Income Tax Return (ITR), and how certain strategies, such as bonus stripping under Section 94(8), can affect your tax liability. Understanding these aspects will help investors make informed decisions and comply with tax regulations effectively.

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Table of Contents

• Taxation of Bonus Shares

• Taxation of Rights Issue

• Reporting in Income Tax Return

• Bonus Stripping and Section 94(8)

• Conclusion

• FAQs

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Taxation of Bonus Shares

Bonus shares are free additional shares given to shareholders by a company in proportion to their existing holdings. While receiving bonus shares does not result in immediate tax liability, there are important tax implications when the shares are sold or transferred.

• No Tax at the Time of Allotment: When bonus shares are allotted, there is no tax implication at that point. The receipt of bonus shares is not considered as income and is not taxable under the Income Tax Act.
  

• Tax on Sale of Bonus Shares: The sale of bonus shares is subject to capital gains tax, with the tax treatment depending on the holding period after their allotment. If bonus shares are sold after being held for more than 12 months (for listed shares) or 24 months (for unlisted shares), they are classified as long-term capital assets, and the gains are taxed as Long-Term Capital Gains (LTCG) at applicable rates. Conversely, if sold within these holding periods, the gains are treated as Short-Term Capital Gains (STCG) and taxed accordingly. It is important to note that bonus shares are not taxable when received, and the holding period for capital gains calculation begins from the date of allotment of the bonus shares. This distinction ensures appropriate taxation aligned with the nature and duration of the investment.

• Cost of Acquisition: For tax purposes, the cost of acquisition of bonus shares is considered to be zero at the time of allotment. However, the cost of acquisition for calculating capital gains is determined based on the original shares' cost. In case the original shares were purchased at a specific price, the cost for the bonus shares is considered to be the same as the original shares' purchase price.

Taxation of Rights Issue

A rights issue is a way for a company to raise capital by offering existing shareholders the right to purchase additional shares at a discounted price. Rights issues come with their own set of tax rules.

• Taxability at the Time of Allotment: Similar to bonus shares, there is no immediate tax liability when rights shares are allotted. The taxpayer does not pay tax upon receiving the rights offer itself.
  

• Taxation on Sale of Rights Shares: The tax treatment of rights shares is similar to that of bonus shares, with capital gains tax applicable on the sale of the rights shares. The holding period for determining short-term or long-term capital gains begins from the date the rights shares are allotted. If the rights shares are sold after being held for more than 12 months (for listed shares) or 24 months (for unlisted shares), the gains are classified as long-term capital gains (LTCG) and taxed accordingly. If sold within these periods, the gains are treated as short-term capital gains (STCG) and taxed at the applicable rates.
  

• Cost of Acquisition: The cost of acquisition of rights shares is determined by the price paid for the rights shares (if they are exercised and purchased). If the rights are not exercised and sold in the market, the sale proceeds are treated as income and taxed as capital gains.

Reporting in Income Tax Return

When dealing with bonus shares or rights issues, it is crucial to correctly report these transactions in the Income Tax Return (ITR) to ensure compliance with tax laws and avoid any discrepancies during the assessment process. The sale of these shares can result in capital gains, which must be reported appropriately to calculate the tax liability. Here's an in-depth explanation of how to report bonus shares and rights issues in the ITR.

Bonus Shares

Bonus shares are issued by a company to its shareholders as a form of additional shares without any cost. The bonus shares are often issued in a specific ratio based on the shares held by an investor. For example, a company might issue one bonus share for every two shares held by an investor.

When it comes to reporting bonus shares in the Income Tax Return, the process involves two main factors:

• Cost of Acquisition of Bonus Shares: The key point with bonus shares is that they do not have any cost of acquisition, as they are issued free of charge. The cost of acquisition for the bonus shares is treated as zero for tax purposes. However, for calculating capital gains when these shares are sold, the original cost of acquisition (i.e., the cost at which the original shares were bought) will be used. Example: Suppose an individual bought 100 shares of a company at ₹50 per share. Later, the company issued 50 bonus shares for every 100 shares. The cost of acquisition of these bonus shares would be considered as zero, but when selling the bonus shares, the cost of acquisition for capital gains tax purposes would be ₹50 per share (the price at which the original shares were bought).
  

• Reporting the Sale: When bonus shares are sold, the capital gains will be calculated based on the sale price minus the cost of acquisition (i.e., the original shares’ cost). The sale proceeds will be reported under the “Capital Gains” section of the ITR. For example, if you sold 50 bonus shares at ₹120 each, the capital gain would be calculated as:

  Sale price = ₹120 × 50 = ₹6,000

  Cost of acquisition = ₹50 × 50 = ₹2,500 (since the original shares were bought at ₹50 each)

  
  

• Capital Gain = Sale Price - Cost of Acquisition = ₹6,000 - ₹2,500 = ₹3,500 (Long-term or short-term capital gain depending on the holding period).
  

• This gain would then be reported under the appropriate section for capital gains in the ITR. If the shares are sold after being held for more than 12 months, the gain would be considered long-term capital gain (LTCG) and would be eligible for tax exemptions or the applicable 10% tax without indexation. If sold before 12 months, it would be considered short-term capital gain (STCG) and taxed at 15%.

Rights Shares

Rights shares are offered by a company to its existing shareholders, allowing them to purchase additional shares at a discounted price. This offer typically comes with a ratio (e.g., 1:1, meaning one right share for every existing share held) and an exercise price. The key difference between rights shares and bonus shares is that rights shares involve the payment of a subscription price, which is often lower than the market price.

• Cost of Acquisition of Rights Shares: The cost of acquisition of rights shares is the amount paid to exercise the rights, which is usually the discounted price offered by the company. If the rights are not exercised and are sold instead, the sale price becomes relevant for calculating capital gains. Example: If an investor holds 100 shares of a company and the company offers one rights share for every existing share at ₹40 per share, the cost of acquisition for each rights share would be ₹40.
  

• Sale of Rights Shares: When you sell rights shares, the transaction is treated similarly to the sale of any other shares. The sale price and cost of acquisition must be reported under the "Capital Gains" section in the ITR. The capital gain is calculated by subtracting the cost of acquisition from the sale price.
  

  If the rights shares are sold, the capital gain will be computed as:

  Sale price = Sale Price of Rights Shares (say ₹100 each)

  Cost of acquisition = ₹40 each (the price at which rights shares were bought)

  Capital Gain = Sale Price - Cost of Acquisition = ₹100 - ₹40 = ₹60 per share
  

• The resulting gain would be reported under "Capital Gains" in the ITR, and the taxation depends on the holding period:
  

  If held for more than 12 months, it is long-term capital gain (LTCG) and may qualify for exemptions or a 10% tax rate.

  If held for less than 12 months, it is short-term capital gain (STCG), which is taxed at 15%.

  
  

  If the rights are not exercised but are sold instead, the sale proceeds are treated similarly, but the cost of acquisition would be the amount paid for the rights shares (the price at which the rights were offered).

Reporting in the ITR

For both bonus and rights shares, the key elements you need to report in your ITR are:

• Sale Price: The amount received upon selling the shares.

• Cost of Acquisition: For bonus shares, this is the original cost of the original shares, and for rights shares, this is the price paid for acquiring the rights.

• Date of Sale: The date when the shares were sold.

• Capital Gains: The difference between the sale price and cost of acquisition.

These details are reported in the "Capital Gains" section of the Income Tax Return (ITR). In the case of bonus and rights shares, accurate reporting is essential to ensure that you calculate the correct capital gains tax liability. Additionally, if the shares are held for more than 12 months, it is important to claim long-term capital gain exemptions (if eligible) or apply the applicable tax rate for LTCG.

Bonus Stripping and Section 94(8)

Bonus stripping refers to a strategy in which an investor buys shares, receives bonus shares, and then sells the original shares (which now have a lower price due to the bonus issue). This strategy is often used to minimize capital gains tax by creating a tax loss on the original shares while benefiting from the bonus shares.

Section 94(8) of the Income Tax Act was introduced to curb such tax avoidance strategies. This section disallows any loss arising from the sale of original shares when bonus shares are received within a specified time frame. If you sell the original shares within 3 months of receiving the bonus shares, any loss incurred on that sale will be disallowed for tax purposes, and the loss will be ignored for calculating your overall tax liability.

This provision was implemented to prevent taxpayers from artificially creating capital losses by exploiting the bonus stripping strategy.

Conclusion

Understanding the taxation of bonus shares and rights issues is essential for investors looking to make informed decisions. While bonus shares are tax-free at the time of allotment, they are subject to capital gains tax when sold. Rights issues, similarly, have their own tax implications but allow for the sale of shares or non-exercise of rights to be taxed as capital gains.

Additionally, the introduction of Section 94(8) aims to curb bonus stripping strategies, ensuring that investors follow proper tax practices. By staying aware of the tax implications of these strategies and reporting them accurately in your Income Tax Return, you can ensure compliance with tax regulations and avoid unnecessary penalties.

For anyone looking for assistance in tax filing, it is highly recommended to download theTaxBuddy mobile app for a simplified, secure, and hassle-free experience.

Frequently Asked Question (FAQs)

Q1: Are bonus shares taxable at the time of allotment?

Bonus shares are not taxable at the time of allotment, as they represent a capitalization of profits rather than income. The tax liability arises only when you sell the bonus shares. The cost of acquisition of bonus shares is considered zero. For capital gains tax purposes, the holding period for bonus shares starts from the date of allotment.

• If bonus shares of listed companies are held for more than 12 months before being sold, the gains qualify as long-term capital gains (LTCG) and are taxed at 10% on gains exceeding ₹1 lakh, without indexation benefits. If sold within 12 months, gains are short-term capital gains (STCG) taxed at 15% (subject to Securities Transaction Tax, STT).

• For unlisted bonus shares, the holding period to qualify for LTCG is more than 24 months. LTCG from unlisted bonus shares is taxed at 20% with indexation benefits. Gains from sale within 24 months are treated as STCG and taxed at the investor’s applicable income tax slab rate.

Q2: How are rights issues taxed?

Rights shares too are not taxable when allotted. The tax arises at the time of sale or transfer of rights shares. The cost of acquisition is the price paid to purchase the rights shares. The capital gains classification depends on the holding period from the date of allotment:

• Listed rights shares held for more than 12 months qualify for LTCG taxed at 10% (above ₹1 lakh exemption), and STCG within 12 months is taxed at 15%.

• Unlisted rights shares held for more than 24 months qualify for LTCG taxed at 20% with indexation; otherwise, gains are STCG taxed at slab rates.

Q3: What is bonus stripping?

Bonus stripping is a tax avoidance strategy in which an investor sells their original shares after receiving bonus shares, intending to create a tax-deductible loss. However, this practice is prohibited under Section 94(8) of the Income Tax Act. The provision disallows any losses that result from the sale of original shares within three months of receiving bonus shares. The aim is to prevent tax evasion through such strategies.

Q4: How do I report bonus shares and rights issues in my ITR?

Bonus shares and rights issues should be reported in the "Capital Gains" section of your ITR. When selling these shares, you must mention both the sale price and the cost of acquisition to calculate capital gains accurately. For bonus shares, the cost of acquisition is considered zero, but the original shares' cost is used for calculating the capital gains. For rights issues, the purchase price of the rights shares is used as the cost of acquisition.

Q5: Does Section 94(8) prevent bonus stripping?

Yes, Section 94(8) prevents bonus stripping by disallowing the deduction of losses from the sale of original shares within 3 months of receiving bonus shares. This provision ensures that taxpayers cannot sell original shares to create an artificial loss after receiving bonus shares, preventing them from reducing their taxable income through this practice.

Q6: When will I be liable to pay capital gains tax on bonus shares?

Capital gains tax becomes payable only when you sell the bonus shares, not at the time of their allotment. The tax liability depends on the holding period. For listed bonus shares, if held for more than 12 months, the gains are classified as long-term capital gains (LTCG) and taxed at the applicable LTCG rate. If sold within 12 months, the gains are treated as short-term capital gains (STCG) and taxed at the corresponding STCG rate. For unlisted bonus shares, the holding period for LTCG classification is more than 24 months; gains on shares held for 24 months or less are treated as STCG.

Q7: Can I claim a tax deduction for the cost of acquisition of rights shares?

Yes, you can claim the price paid for purchasing the rights shares as the cost of acquisition for calculating capital gains tax when you sell those shares. This cost will be deducted from the sale proceeds to determine the capital gains, which will be taxed according to whether the gains are short-term or long-term, based on the holding period.

Q8: What happens if I don't exercise the rights issue?

If you do not exercise your rights issue, you have the option to sell the rights entitlement in the market. The sale of these rights is treated as a transfer of a capital asset, and any gains from the sale are subject to capital gains tax. The classification of the gains as short-term or long-term depends on the holding period of the rights—more than 12 months for listed rights shares and more than 24 months for unlisted rights shares—with corresponding tax treatment.

Q9: Is there any tax benefit for holding bonus shares for a longer period?

Holding bonus shares for the prescribed period qualifies you for long-term capital gains tax at concessional rates. Specifically, LTCG on listed shares held for more than 12 months is taxed at 10% (for gains exceeding ₹1 lakh) without indexation, while LTCG on unlisted shares held for more than 24 months is taxed at 20% with indexation benefits. This tax structure incentivizes holding bonus shares for the applicable period to optimize tax liability.

Q10: How can I calculate the cost of acquisition for bonus shares?

The cost of acquisition for bonus shares is considered zero. However, when calculating capital gains, the cost of acquisition of the original shares is used. The capital gains are determined based on the difference between the sale price of the bonus shares and the original shares' cost, taking into account the holding period for long-term or short-term capital gains.

Q11: Are bonus shares issued by private companies taxed differently than public companies?

No, bonus shares are taxed the same way, regardless of whether the company is private or public. The tax treatment does not depend on the company's classification. Both public and private companies issue bonus shares, which are subject to capital gains tax when sold, based on the holding period.

Q12: How do I avoid penalties when reporting bonus shares or rights issues in my ITR?

To avoid penalties when reporting bonus shares or rights issues in your ITR, it’s essential to accurately report the sale price and cost of acquisition. Ensure that you correctly calculate the capital gains by following the guidelines set by the Income Tax Department. Failure to report correctly may result in penalties or interest on unpaid taxes, so it's important to provide accurate details in your tax return. Using a reliable platform like TaxBuddy can help you avoid common mistakes and ensure your tax filing is error-free.