What is meant by bonus share in Share Market?

Meaning:

The Bonus shares refers to the distribution of company’s reserves to the equity shareholders by giving them ‘extra’ shares on the basis of their previously held shares. Thus giving bonus shares is a sign of positive financial status of a company.

Advantage to the retail investor:

Increase in the wealth of the retail investor:

Before we go to this part, let me tell you a different story. ‘Two halves are more than one full’.

You and your friend go to a restaurant. You both decide to order ‘one’ lip smacking tomato soup. But then you decide to place an order for ‘two’ half tomato soups instead of ‘one’ full tomato soup. More often than not the quantity of two halves combined will be more than one full. This same psychological thing happens when a company declares bonus.

Say a company has a share price of Rs.1000. It decides to give bonus shares in the ratio of 1:1. Thus a member with 100 shares will now have 200 shares. Logically speaking the share price must reduce to half at Rs.500. However, the psychological thing comes into play. Thus, the stock price is adjusted to a little more than Rs.500. Not just this, there will be more volume as the shares are trading at lesser price. Hence, the shareholders would be rewarded.

Tax planning:

Before we go into the details, there are few basics which everyone needs to know:

  1. If the shares are held for more than one year, the gain arising shall be long term. Otherwise, it shall be considered as short term.
  2. In case of long term capital gain on sale of shares on a recognized stock exchange where STT (Securities Transaction Tax) is paid, the gain shall be exempt to the extent of Rs.1 lakh per annum.
  3. However, if the gain in the above case is short term, then tax shall be levied at 10% of the gain.
  4. Shares are taxed on FIFO (First In First Out) basis. Simply speaking, the shares bought first shall be adjusted first while selling.

Consider this example,

Here, the investor originally had 100 shares on 1.1.18 bought at Rs.150 a piece. As the company announced bonus shares, the total shares doubled to 200.

Now, whenever a company announces bonus, the investor must sell half of the shares the next day the bonus is allotted. Selling them early would result into short term loss. The remaining half shares must be held for more than one year. This will make the gain as long term.

In the table above, the investor did the same. He sold only 100 shares on 1.6.18 at Rs.75. The buying price on 1.1.18 was Rs.150. When the company announced bonus the shares doubled but the share price was reduced to half.

Now, as per FIFO, the 100 shares sold on 1.6.18 at Rs.75 will be assumed to be the shares bought first on 1.1.18 at Rs.150. This will result into short term capital loss of Rs.75 per share. Therefore, the total short term loss shall be Rs.7500. This loss can be adjusted against other short term capital gain and one can reduce the short term capital gain tax liability which otherwise would have been taxed at 10%. The remaining 100 shares must be sold after 1 year to turn them into long term and this will now help one in claiming exemption of Rs.1 lakh.

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