Mutual Funds – You’ve got bonus. And that too tax-free

How about getting bonus without having to pay up any tax on it? Sounds interesting. Wondering whether it can be possible? Perhaps you have not heard of Bonus stripping.

Bonus stripping is buying a financial asset like shares/mutual fund unit on which bonus is declared before the record date of declaration of bonus to the investors and later selling the original quantity of financial asset bought, to book a loss for income tax purposes.

So legally and technically you would be booking a loss whereas its a major gain. Quite legal of course, it can be called tax avoidance or deferring tax payment.

For instance lets say an individual buys 10,000 units of a fund at a net asset value of Rs 10 per unit for a total amount of Rs 1,00,000. With the bonus announcement of 1:1 on the fund the NAV would go up to Rs 11 per unit.

After bonus the individual would be having a total of 20,000 units and the NAV of the fund post-bonus would drop to Rs 5.50 per unit which means his total amount would be Rs 1,10,000. After bonus you would be having a total of 20,000 units and the NAV of the fund post-bonus would drop to Rs 5.50 per unit which means the total amount would be Rs 1,10,000. On the sale of the original 10,000 units, you would suffer a short term capital loss, as the mutual fund units are held for a period not exceeding one year.

Hence for income tax purposes you will be registering a short term loss but financially speaking you have made a gain.