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Wednesday, August 17, 2011

How Bonus Shares Can Save Your Tax

Mr. Verma earned huge Short Term Capital Gain (STCG) of Rs 90,000 in shares but when he came to know that he is liable to pay Rs. 13,500 (& other due taxes) as tax, he was disappointed.
STCG (short term capital gain), on shares is applicable when  shares bought are sold before the completion of 365 days (1 year) through a recognized stock exchange and STT is paid on it.
Presently, STCG is applicable at the rate of 15% on the Short Term Capital Gain (earlier it was 10%).
How Mr.  Verma could have avoided this taxation?
 
·         Simple option with him was, sell shares after the period of one year from the date of purchase; shares sold after the completion of 1 year attracts LTCG (Long Term Capital Gain) which is completely tax exempt i.e. no tax is applicable on LTCG provided transaction done through a recognized stock exchange and STT is paid on it. But this solution is often not viable owing to market conditions.

·         There is another smart solution.
Buy some quality stocks, which are going ex-bonus before the ex-date. If 1:1 bonus is announced then investor shall get 1 share (of same face value) for each share investor is holding, in simple words his shares shall be doubled.

How Mr.  Verma can reduce his STCG?

Ashok Leyland stock which went ex-bonus on August 2, 2011, and the bonus was 1:1(1 bonus share on 1 share held)
If Mr. Verma buys this share on August 1, 2011 or prior, he becomes entitled for the bonus shares.
So 3000 Ashok Leyland shares bought by Mr. Verma becomes 6000 with halved market price (3000 shares bought at Rs. 52 becomes 6000 shares of market price Rs. 25)
Buying bonus shares does not give any significant portfolio appreciation but gives amazing tax benefits.
If Mr. Verma sells 3000 shares, he undergoes huge capital loss as he bought the shares at Rs. 52 and now selling those for Rs. 25 thus it gives 27 Rs. Short Term Capital Loss (STCL) per share.
So by selling 3000 shares Mr. Verma attracts Short Term Capital Loss of 81,000 Rs.
And as Short Term Capital Loss can be set –off against Short Term Capital Gain, now Mr. Verma has to give STCG tax on only 9000 Rs. (90,000 STCG-81,000 STCL) which is Rs. 1350 only.

Now Mr. Verma says: - ‘I am loving it’.

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