Don't let taxation mar your bonus share gains

Investors in the second-largest IT firm Infosys have been rejoicing the announcement of bonus shares made this month. Essar India, Deepak Nitrite, MindTree and more than 30 other companies too have made bonus share offerings in 2014 so far.
Even as one cheers the increase in the number of shares due to bonus allotment, they should be wary of selling the old or the new shares at the wrong time and end up in a tax tangle.
Under a bonus share allotment, existing shareholders get additional shares in the ratio that is announced. For instance, if a company says it will allot 1:1 bonus shares, your total number of shares will double. If you originally hold 100 shares, you will get additional 100 shares, which would be new shares.
Don't fret once you get the bonus shares as there are no taxes to be paid once the bonus shares are allotted. The tax liability only applies when you sell them, depending on how long you owned them.
"When you start selling shares partially, the shares that entered your demat account first would be sold first. If you originally had 1,000 shares and were allotted 1,000 bonus shares, then the original shares would be considered to be sold first," explains Ameet Patel, partner at Sudit K Parekh & Co.
Now let us understand the taxation under various circumstances

Zero tax
If these 1,000 original shares have been owned for more than 12 months then you won't have to bear any tax.
Sunil Talati, former president of Institute of Chartered Accountants in India, advises, "One should ideally hold the bonus shares to a minimum of 12 months to avoid adverse tax impact. Once the shares are held for the long term (more than 12 months) then they aren't taxed."
Similarly, holding the bonus shares for at least a year then then selling would ensure that the entire profit earned would be tax-free.

Tax neutral
If you sell both the original and the new shares at the same time but before the completion of 12 months then you would make a loss on the original shares as the stock price tends to halve after the bonus share allotment. Since you are selling the shares before completion of a year this is short-term capital loss.
"One can set off short-term loss against any other taxable long-term gains," says Patel.
When it comes to the bonus shares, the acquisition price is considered zero. So, you would always make a profit on the sale of new shares. "If you sell them within a year of the record date then you have to bear a 15% tax. As these bonus shares came at zero cost the entire amount involved in the transaction is taxed," adds Patel.

Higher tax than gains
There is also a situation under which you would shell out more tax than the actual gains made. Consider a situation where a shareholder sells all the shares after the bonus share issuance where the original shares have been held for more than a year, but the new shares earned in bonus haven't been owned for more than a year. He would end up paying high tax in this situation as his original shares would be making a loss.
Assume he held 1,000 shares priced at Rs 100. After the bonus issue in the ratio of 1:1, he would have 2,000 shares and the price would nearly halve. So, if he sells all the 2,000 stocks at the price of Rs 60 then the shareholder would make:
Old Shares: Loss of (Rs 100-60) * 1000 = 40,000
New Shares: Gain of (Rs 60-0) * 1000) = 60,000

Since you are selling the old shares after the completion of a year the loss of Rs 40,000 cannot be set off against any other gains made. On the other hand, new shares being sold before completion of a year would attract a tax of 15%, which could have been avoided by holding the new shares for a little longer.
As a result you end up with a loss that you cannot adjust and gains which would be taxable.
Hence, the selling period of both old and new shares is crucial if you do not want to end up paying high taxes.
A useful suggestion in this regard comes from Talati, who says, "To avoid confusion regarding shares that were earned in bonus, it is advisable to demat the new shares in a separate demat account."