Taxation of Bonus Shares
This sub‑topic explains how bonus shares are taxed in India. It covers the tax‑free nature at issuance, the method of determining cost of acquisition, and the capital‑gains implications when the shares are sold. Understanding these points is essential for answering NISM Series X‑B exam questions on equity‑related tax provisions.
Learning Objectives
- 1Define bonus shares and differentiate them from rights and dividend shares.
- 2Explain why bonus shares are not taxed at the time of issue.
- 3Calculate the cost of acquisition for bonus shares using the apportionment method.
- 4Identify the capital‑gains tax treatment and holding‑period rules for bonus shares.
What are Bonus Shares?
Bonus shares are additional equity shares issued to existing shareholders free of cost, drawn from the company's free reserves or accumulated profits. The issue is proportionate to the holdings of each investor, for example a 1:1 bonus means one extra share for every share held.
The purpose of a bonus issue is to reward shareholders, improve market liquidity, and convert reserves into share capital without any cash outflow. Under the Companies Act, 2013, a company may issue bonus shares only out of free reserves, securities premium account or capital profit, and the issue must be approved by the board and shareholders.
For the NISM exam, remember that bonus shares are a capital‑raising tool, not a dividend distribution. This distinction drives the tax treatment, which is examined frequently in the taxation section of the Investment Adviser certification.
Tax Treatment at the Time of Issuance
When bonus shares are allotted, the shareholder receives them without any cash consideration. Consequently, the Income Tax Act treats the receipt as a non‑taxable event; there is no tax liability at the moment of issue.
Bonus shares are not classified as dividend income, so the dividend distribution tax (DDT) does not apply. The tax exemption is based on the principle that the shareholder is merely converting a portion of retained earnings into share capital, not receiving a cash profit.
Exam candidates often need to select the correct statement among options such as “Taxable as dividend”, “Subject to capital gains at issue”, or “Tax‑free at issue”. The correct answer is the tax‑free option.
Many candidates mistakenly treat bonus shares as dividend income and choose options involving dividend tax. Remember: bonus shares are a capital event, not a dividend, and are tax‑free at the time of issue.
Cost of Acquisition for Bonus Shares
Although the receipt of bonus shares is tax‑free, the cost of acquisition for capital‑gains purposes is not zero. The Income Tax Rules require the original purchase cost to be apportioned between the original and the bonus shares in proportion to their numbers.
The formula used is: Cost per share = Total cost of original shares ÷ (Original shares + Bonus shares). This apportioned cost becomes the acquisition cost for each bonus share when the investor eventually sells them.
Understanding this apportionment is crucial because the capital‑gains tax is calculated on the difference between the sale price and the apportioned cost. Failure to apply the correct cost base leads to mis‑calculation of tax liability, a common source of errors in NISM questions.
Where:
TotalCost= Aggregate purchase cost of the original shares (in rupees)OriginalShares= Number of shares originally held before bonus issueBonusShares= Number of bonus shares receivedWorked Example
Given TotalCost = 10,000, OriginalShares = 100, BonusShares = 100: Step 1: C = 10,000 ÷ (100 + 100) Step 2: C = 10,000 ÷ 200 = 50 rupees per share Verification: 10,000 ÷ (100 + 100) = 50.
Capital Gains Tax on Sale of Bonus Shares
When a bonus share is sold, the capital‑gains tax is triggered based on the holding period. If the share is held for more than 12 months, it qualifies as a long‑term capital gain (LTCG) and is taxed at 10% (exceeding INR 1 lakh) without indexation. If held for 12 months or less, it is a short‑term capital gain (STCG) taxed at the individual's slab rate.
The holding period for the bonus share is counted from the date of issue of the original shares, not from the date the bonus shares were allotted. This means that an investor who bought the original shares two years ago and received a bonus share today will already satisfy the LTCG holding period.
Exam questions may present a scenario with dates of original purchase, bonus issue, and sale. Candidates must correctly compute the holding period and apply the appropriate tax rate.
Do not start the holding period from the bonus‑issue date. The period begins with the acquisition date of the original shares, which often reduces the tax rate to LTCG.
Comparison: Bonus, Rights, and Dividend Shares
Tax implications of different types of share entitlements
| Aspect | Bonus Shares | Rights Shares | Dividend Shares |
|---|---|---|---|
| Tax at issuance | Tax‑free (capital event) | Tax‑free if issued at nominal price | Taxable as dividend – DDT applies |
| Cost of acquisition | Apportioned from original cost | Purchase price paid for rights | No cost – dividend income only |
| Capital gains tax on sale | Based on apportioned cost, STCG/LTCG rules | Based on purchase price, STCG/LTCG rules | Not applicable – dividend already taxed |
| STT on sale | Applicable at normal equity‑sale rate | Applicable at normal equity‑sale rate | Not applicable |
Illustrative Example
Scenario
An investor bought 100 equity shares of ABC Ltd. on 1 Jan 2022 at ₹120 each (total cost ₹12,000). On 1 Jan 2023, the company issued a 1:1 bonus. The investor sells 80 bonus shares on 1 July 2024 at ₹150 each.
Solution
Step 1: Determine total shares after bonus – 100 original + 100 bonus = 200 shares. Step 2: Cost per share = 12,000 ÷ 200 = ₹60. Step 3: Cost of 80 bonus shares sold = 80 × 60 = ₹4,800. Step 4: Sale proceeds = 80 × 150 = ₹12,000. Step 5: Capital gain = 12,000 – 4,800 = ₹7,200. Step 6: Holding period = from 1 Jan 2022 to 1 July 2024 = 2.5 years (>12 months) → LTCG. Step 7: LTCG tax = 10% of ₹7,200 = ₹720 (since gain exceeds ₹1 lakh exemption, tax applies on the whole amount).
Conclusion
The investor pays ₹720 LTCG tax on the sale of bonus shares. The example highlights cost apportionment, holding‑period calculation, and the applicable tax rate.
Impact on Securities Transaction Tax (STT)
STT is levied on the sale of listed equity shares, irrespective of whether they are original or bonus shares. The rate for equity delivery‑based sales is currently 0.1% of the transaction value.
Therefore, when the investor in the example sells bonus shares, STT of 0.1% on ₹12,000 (sale proceeds) equals ₹12, which is payable in addition to capital‑gains tax.
Exam questions may ask for the total tax outflow, requiring candidates to add both LTCG tax and STT. Remember that STT is always applicable on the sale side, not on receipt of bonus shares.
Cost per Share for Different Bonus Ratios (Total Cost ₹10,000, Original Shares 100)
Practical Tips for Investment Advisers
Advisers should always request the original purchase invoice or broker statement to determine the total cost of the original shares. This document is the basis for the apportionment calculation.
When advising clients on selling bonus shares, verify the holding period of the original shares to correctly classify the gain as STCG or LTCG. Use the formula provided earlier to compute the cost base quickly.
Maintain a clear record of the bonus‑issue ratio, as it directly influences the cost per share. A simple spreadsheet can automate the apportionment for multiple bonus issues over the investment horizon.
Many advisers treat the cost of bonus shares as zero, leading to overstated capital gains. Always allocate the original purchase cost proportionally.
Regulatory References
The tax treatment of bonus shares is governed by Section 10(34) of the Income Tax Act, 1961, which exempts the receipt of bonus shares from tax. The cost‑allocation rule is detailed in Rule 112B of the Income Tax Rules.
SEBI’s Listing Regulations require companies to disclose the bonus‑issue ratio and the date of issue, which helps advisors determine the holding period for capital‑gains purposes.
For the most up‑to‑date rates of LTCG, STCG, and STT, refer to the latest Finance Act and the Securities and Exchange Board of India (SEBI) circulars.
⭐Exam Takeaways
- Bonus shares are tax‑free at issuance; they are a capital event, not a dividend.
- Cost of acquisition for bonus shares is apportioned: Cost per share = TotalCost ÷ (OriginalShares + BonusShares).
- Holding period for capital‑gains starts from the original share purchase date, not the bonus‑issue date.
- LTCG tax is 10% (above the ₹1 lakh exemption) and STCG tax follows the individual’s income‑tax slab.
- STT at 0.1% applies on the sale of bonus shares, just like any other listed equity.
Practice Questions
8 questions on Taxation of Bonus Shares
What are bonus shares?
How are bonus shares taxed at the time they are issued?
An investor’s original share purchase cost is ₹15,000 for 150 shares. The company issues a 1:1 bonus. What is the cost per share after apportionment?
From which date is the holding period for bonus shares calculated?
An investor bought 200 shares for ₹24,000 on 1 Jan 2021. A 1:2 bonus was issued on 1 Jan 2022. The investor sells 150 bonus shares on 1 Aug 2023 at ₹200 each. What is the long‑term capital gains tax payable (10% on the gain)?
Using the illustrative example where sale proceeds are ₹12,000, what is the Securities Transaction Tax (STT) payable at 0.1%?
Which statement correctly describes the tax at issuance for bonus, rights, and dividend shares?
Which provision contains the rule for cost allocation of bonus shares?