Bonus Stripping

Bonus stripping refers to the practice of selling bonus shares that arise from a corporate bonus issue while retaining the original shares. The investor typically purchases the equity before the bonus issue, receives bonus shares at no cost, and then sells the bonus portion to realise a capital gain.

The key idea is that the cost of acquisition for bonus shares is deemed to be zero under the Income Tax Act. Consequently, any sale proceeds from the bonus shares are treated as pure capital gains, which can be taxed at the short‑term or long‑term rates depending on the holding period.

For the NISM exam, you must recognise that bonus stripping is not a prohibited activity; it is a legitimate tax‑saving strategy, provided the adviser discloses it to the client and complies with SEBI’s suitability norms.

• Bonus shares are issued in a predetermined ratio (e.g., 1:1, 2:1) and are credited to the shareholder’s demat account automatically.
• The original shares and bonus shares can be sold in separate transactions, each attracting its own tax treatment.

When bonus shares are sold, the Income Tax Act treats them as a separate asset with a cost base of ₹0. Therefore, the entire sale consideration (minus transaction expenses) is taxable as capital gain.

If the bonus shares are sold within 12 months of receipt, the gain is classified as short‑term capital gain (STCG) and taxed at a flat 15% (plus applicable surcharge and cess). If the holding period exceeds 12 months, the gain qualifies as long‑term capital gain (LTCG) and is taxed at 10% on the amount exceeding the annual exemption of ₹1 lakh.

These rates apply irrespective of the investor’s ordinary income tax slab, making bonus stripping attractive for high‑income clients who would otherwise face a higher marginal rate on ordinary income.

The formula above is the standard capital‑gain computation prescribed by the Income Tax Act. Because the cost of acquisition for bonus shares is zero, the entire sale proceeds (after deducting brokerage and other expenses) become taxable.

Advisers should always collect the exact brokerage amount (E) to avoid over‑ or under‑stating the gain. The tax payable is then obtained by applying the appropriate STCG or LTCG rate to the CG figure.

Remember that the 10% LTCG rate applies only after the aggregate LTCG in a financial year exceeds the exemption limit of ₹1 lakh. If the client’s total LTCG from all equity holdings is below this threshold, no tax is due even after a profitable bonus‑stripping transaction.

The tax rate applied to the gain from bonus shares hinges on the holding period counted from the date of receipt of the bonus shares. If the bonus shares are sold within 12 months, the gain is short‑term and taxed at 15%.

If the investor holds the bonus shares for more than 12 months, the gain becomes long‑term and is taxed at 10% on the amount exceeding the ₹1 Lakh exemption. This can significantly reduce tax outflow for high‑value transactions.

Advisers should therefore counsel clients on the optimal timing of the sale: a short‑term sale may be preferable when the client needs liquidity and is comfortable with the 15% rate, while a long‑term sale is advantageous for tax efficiency if the client can wait.

1. Identify Bonus Eligibility: Verify the bonus issue ratio, record date, and entitlement date for each client’s holdings.

2. Separate Transaction Records: Maintain distinct purchase‑sale logs for original shares and bonus shares to ensure correct cost bases.

3. Calculate Expected Tax: Use the capital‑gain formula to project tax liability under both short‑term and long‑term scenarios. Present the comparison to the client.

4. Compliance Check: Ensure that the recommendation complies with SEBI’s suitability obligations and that the client’s risk profile aligns with the timing of the sale.

5. Documentation: Record the advice, calculations, and client acknowledgment in the advisory file for audit purposes.