Every investor has heard about stock splits and bonuses in the news, riddled with complex-looking ratios and reasoning behind these moves. Does it really affect the investor?
What Are They?
Company increases the number of outstanding shares held by existing investors by essentially splitting the value of one share in a specified ratio
Company issues “free” additional shares using its reserves to existing investors in a specified ratio
How Does It Work?
Splits the value of a single share, but increases its number, making it affordable and liquid to trade in
The company issues extra shares, but the value of each share reduces, making it affordable and liquid to trade in
An investor has 1 share worth Rs. 100
After a 2:1 split, the investor now has 2 shares worth Rs. 50 each
An investor has 1 share worth Rs. 100
After a 2:1 bonus issue, the investor now has 3 shares worth Rs. 33 each
Here is a TLDR in case you couldn't be bothered to read our cute table:
Stock Splits and Bonus Issues might be fundamentally different, wherein the former is the splitting of the value of each share, and the latter is the increase in the number of shares held, yet the implications are similar
Both result in more outstanding shares and a reduction in the value of each share. Essentially, both result in the share price reduction, making stocks more affordable and liquid; neither of the actions however affects the stock’s market cap or net worth
These phenomena can even cause the stock’s price to surge in anticipation of these stocks being available to a larger investor base due to the affordability aspect!
💡 One must keep in mind that an investor is only eligible for a stock split or bonus share issue if they hold shares on or before the specified record date
How Are They Taxed?
Now that we’ve established what those two phenomena are, an investor must also be aware of the tax implications of being a part of such a situation.
Prior to 2019, the tax rate on these corporate actions was determined based on the individual shareholder's tax bracket. However, in 2019, the government implemented a new tax methodology that changed the way stock splits and bonuses are taxed.
Now, the tax rate is calculated based on the market value of the shares on the date of the split or bonus and the duration for which they are held and eventually sold.
As norms state, selling before the end of a whole year will be taxed under Short Term Capital Gains of 15% and over a year will be taxed at Long Term Capital Gains of 10%.
Since we’re just the nicest people, we’ve come up with a hack for you to save on those taxes as well.
Visit our blog on Tax Loss Harvesting to know more!
How to Deal With Splits and Bonuses
When a company announces a stock split or bonus, you, as a shareholder have several options to consider:
Hold onto the additional shares if you are positive about the long-term prospects of the company and think the shares will rise materially in value over time
Sell the additional shares for a profit
It is important for you to carefully consider your options and the potential tax implications before making a decision. Some things to consider include:
Current Market Value: If the market value of the shares is significantly higher than it was when you first purchased them, selling the additional shares may be a good option to realise a profit
Investment Goals: If you are confident about the prospects of the company, and think you will see material appreciation in value over time, holding onto the additional shares may be the best option
Taxes: It is also important for you to keep track of any changes to the tax treatment of stock splits and bonuses in India, as these changes can have a significant impact on the overall value of the investment
In summary, stock splits and bonuses can be useful tools for companies to increase liquidity and make their stock more accessible to a wider range of investors.
However, it is important for shareholders to carefully consider the tax implications and their own investment goals before making a decision about how to handle these corporate actions.
By staying informed and making informed decisions, you can maximise the benefit of stock splits and bonuses and maximize your return on investment.