Union Budget 2022: HNIs can’t evade taxes through ‘bonus stripping’ from April 2023

Wealthy investors, who routinely suppressed their tax liabilities through a practice known as bonus stripping, will no longer be able to do that from April 1, 2023. That is because of an amendment introduced to the Income Tax Act in the Budget.

First of all, what is bonus stripping?

Assume an investor buys 1000 shares of a company at Rs 100 each. Soon after, the company declares a bonus issue in the ratio 1:1. The price of the stock now drops to Rs 50 (because there are twice as many shares in the market now). The investor now has 2000 shares of Rs 50 each. He will sell 1000 shares of at Rs 50, and show it as a loss in his books, since he had bought the shares at Rs 100 apiece. This loss of Rs 50,000 can then be set off against the capital gains made in other transactions. Remember, the investor is still holding the balance 1000 shares he received as bonus.

Section 94(8) of the Income Tax Act covers the taxation of bonus units of mutual funds, thereby preventing bonus stripping by the tax payer. However, the rule was not applicable to bonus equity shares of companies. The Budget changes that.

“Bonus shares, units, etc. can be used for tax avoidance wherein a person may buy shares/units just when the bonus is announced by the issuer and after the bonus shares/units are granted, the price of shares/units ordinarily falls to adjust for increased shares/units. The person may immediately sell some of those shares/units and applying FIFO method, can claim loss on sale of those shares/units. "Under Bonus stripping provisions, the loss so generated is not allowed to be claimed in the computation of income if the units are sold within 9 months. The provision as of now is applicable on Mutual fund units but is sought to be extended to shares and units of REITS/Invits as well," said Sandeep Sehgal, Tax-Partner, AKM Global, a tax and consulting firm.

From the Finance bill:

“It is proposed to amend sub-section (8) of said section so as to provide that the provisions of the said sub-section shall also be applicable to securities.

It is further proposed to substitute clause (aa) of the Explanation to the said section, so as to substitute the definition of the expression "record date" to mean such date as may be fixed by a company, or a Mutual Fund or the Administrator of the specified undertaking or the specified company referred to in the Explanation to clause (35) of section 10; or a business trust as defined in clause (13A) of section 2; or an Alternative Investment Fund as defined in clause (b) of sub-regulation (1) of regulation 2 of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, made under the Securities and Exchange Board of India Act, 1992, for the purposes of entitlement of the holder of the securities or units, as the case may be, to receive dividend, income, or additional securities or unit without any consideration, as the case may be. It is also proposed to amend clause (d) of the aforesaid, Explanation to amend the definition of the term “unit”.

These amendments will take effect from the 1st April, 2023 and will, accordingly, apply in relation to the assessment year 2023-2024 and subsequent assessment years."