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Dividend is a crucial source of income for stock investors over the long term, and one of the ways in which such dividend is paid out is through stock dividends, i.e., bonus shares. In the hands of investors, cash dividends are tax-free because the firm announcing the dividend pays dividend distribution tax on it, resulting in investors using the technique of Bonus Stripping. The article discusses the concept of bonus Stripping & Tax on Bonus Shares under ITA 1961.
Bonus shares refer to the additional shares provided to the current shareholders by the company as a bonus in the event of the company’s inability to pay a dividend to its shareholders despite earning decent profits for the quarter. Such shares can only be issued by the company to its shareholders as per their stake in the same.
Bonus Stripping is a strategy adopted by investors for the purpose of reducing the tax burden under the IT Act 1961. Under this type of arrangement, an investor willing to reduce the tax burden applicable to his assessment purchases stocks before the record date & sells off the units post the record date, when the unit price becomes ex-bonus. Holding the units on the record date makes the person eligible for additional units declared by the company without paying any additional amount.
The advantages of bonus stripping are enlisted below –
This strategy has some disadvantages as well, which are enlisted below-
The provisions that keep a check on this strategy are provided under section 94(8) of the IT Act 1961, which states as under-
The provisions of section 94(8) become applicable only upon the satisfaction of the above-mentioned conditions; then, the loss arising on account of the sale of all or any such units would be ignored for computation income chargeable to the tax of the respective person. It must be noted by the taxpayers that the loss ignored would be assumed to be the cost of acquisition of such additional unit held by the person as on the date of such sale/transfer.
The amendments proposed in Section 94(8) of the Income Tax act, is regarding the enforcement of the applicability of bonus stripping and dividend stripping provisions for securities and units also, vide Clause 25 of the Finance Bill 2022 (budget 2022-23), which is discussed below
The acquisition and disposal of the shares weren’t made with the primary goal of avoiding taxes; the loss on bonus stripping can be offset under existing laws. If such stripping was done solely for the purpose of avoiding taxes, the assessing officer might attach cost on a proportionate basis to the original and bonus shares. Therefore it is important for the investor to have a thorough knowledge of this concept, its legality and its current status as the IT Act before making any decision.
Read Our Article: Some Common Penalties under Income-Tax Act, 1961
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