Budget bans bonus stripping of shares, units of Reit, InvIT

3 min read 03 Feb 2022, 06:21 AM IST

Bonus stripping is an act of buying the units of a fund with an intent to earn bonus units and sell original units at less price

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Budget 2022 proposes to include shares and units of Infrastructure Investment Trust (InvIT) or Real Estate Investment Trust (Reit) or Alternative Investment Funds (AIFs) in the anti-avoidance provisions of the Income Tax Act related to bonus stripping.

Here, we look at what bonus stripping is, its taxability and the changes to it proposed by the Budget.

Bonus stripping

Bonus stripping is an act of buying the units of a fund with an intent to earn bonus units and thereafter sell original units at reduced prices. This is to use the loss incurred on sale of original units to set-off against other capital gains.

Say an investor named ‘X’ bought 500 units at ₹100 each just before the record date of the bonus issue of 1:1. Post the bonus issue, X holds 1,000 units and the unit price would fall to ₹50 each; the unit price of the fund falls post the bonus issue in the same proportion of bonus units issued.

In case of bonus stripping, X would sell, say, 500 units at ₹50 each after bonus issue and decide to use the loss of ₹25,000 (500X( ₹100 – ₹50)) to set off against capital gains.

The remaining units acquired on bonus may be held for more than one year. This is to benefit from LTCG tax on equity units, which are taxed at concessional rate of 10% on gains in excess of ₹1 lakh.

Investors may indulge in such activities to optimize the total tax outgo.

To check such activities by investors, the Income Tax Act has a section that disallows set-off of loss incurred through bonus stripping against other capital gains.

Section 94 (8) of the Income Tax Act implies that when units are bought within three months prior to the record date of a bonus issue and sell some of the units within nine months after the record date, the loss incurred in such case will be ignored.

In the above case, say X sold 500 number of units within 9 months from record date, the loss incurred, therefore, ( ₹25,000 in this case) will be ignored for taxation purpose. However, the amount of loss so ignored will be considered as the cost of acquisition of the units that investor continues to hold. Here, ₹25,000 will be the cost of acquisition of the 500 bonus units that X hold to sell at later date.

What’s new?

Earlier, the anti-avoidance section of section 94(8) was applicable only for units of mutual fund.

The budget proposes to include securities as well in addition to mutual funds. Securities include shares. This is to curb bonus stripping activities in the share market.

In addition to this, budget also proposed to revise the definition of units to include units of new pooled investment vehicles such as InvIT or Reit or AIFs.

“Bonus stripping is used in AIFs, where bonus units are issued, and some are stripped off after the issue to book a loss. There was a need to plug the loophole in case of bonus stripping," said Amit Agarwal, partner at Nangia Andersen India.

The revised definition of ‘units’ will also make dividend stripping provisions of income tax applicable to units of InvIT or Reit or AIFs. Dividend stripping is a similar concept to bonus stripping, where the users intend to benefit from capital loss arising on sale of shares at lower price post-dividend. This concept holds little relevance now, as dividends are taxable in the hands of the shareholder, unlike earlier, and makes the tax planning less effective.

“While amendments can be made to cover Reits/InvITs under the purview of dividend stripping provision of the IT Act, it will not have any impact, as one cannot apply the section because the income is anyway taxable," said Agarwal.

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ABOUT THE AUTHOR

Satya Sontanam

Satya Sontanam is a senior content creator at Mint with a keen interest on data crunching, analysis and the story behind trends. She writes on personal finance including investments, regulations and data stories. Before joining Mint in December 2021, Satya worked as research analyst and also a personal finance writer at The Hindu BusinessLine. Satya is a qualified chartered accountant. In her free time, she enjoys doing yoga and listening to podcasts.