Tax on Bonus Shares
Under Indian income tax law, bonus shares issued by a company carry a cost of acquisition of zero in the hands of the shareholder — a rule codified in Section 55(2)(AA) of the Income Tax Act — meaning the entire sale proceeds on disposal of bonus shares are treated as capital gains, with the holding period and applicable tax rate determined by the share type and tenure.
Bonus shares are additional shares issued to existing shareholders free of cost out of the company's accumulated reserves, typically in a fixed ratio such as one bonus share for every two shares held. No cash changes hands; the company capitalises its reserves, and the shareholder receives additional shares without paying consideration.
Prior to an amendment made by the Finance Act 2017, a tax planning technique existed where investors would purchase shares of a company just before a large bonus issue, receive the bonus shares at near-zero cost, and then sell both the original and bonus shares after one year to claim Long Term Capital Gains (LTCG) exemption. The amendment plugged this by making bonus shares on listed securities exempt from LTCG only if the original holding had been held long enough to pass the twelve-month threshold independently.
The current position under Section 55(2)(AA) is unambiguous: the cost of acquisition of bonus shares is nil. When bonus shares are sold, the entire sale consideration (minus brokerage and STT) constitutes the capital gain. The tax rate applied depends on whether the holding qualifies as short-term or long-term. For listed equity shares, a holding of more than twelve months qualifies as long-term, attracting LTCG tax at 12.5% (post the Union Budget 2024 revision from the earlier 10%) on gains exceeding Rs 1.25 lakh (revised from Rs 1 lakh) in a financial year. Holdings up to twelve months attracted STCG at 20% (revised from 15% in Budget 2024).
The grandfathering provision introduced via the Finance Act 2018 applied to original shares and to bonus shares allotted before 31 January 2018 on listed equity. For such bonus shares, the cost for grandfathering purposes was taken as the fair market value (highest price on the recognised stock exchange) on 31 January 2018, or the actual sale price, whichever was lower. This reduced the taxable gain on pre-January 2018 bonus shares significantly for many long-held positions.
For unlisted shares, the holding period for long-term classification was twenty-four months, and the LTCG tax rate was 20% with indexation benefit. Bonus shares on unlisted companies also carried nil cost of acquisition, but the grandfathering provision applied only to listed shares.
Practically, bonus shares created record-keeping challenges. Portfolio tracking software and broker back-office systems had to correctly record the bonus allotment date and the nil cost, and distinguish between original shares (which had an actual purchase cost) and bonus shares (nil cost) when computing FIFO or LIFO disposal sequences for tax calculation purposes.