Understanding Stock Split, Bonus Issue & Share Buy-Back

16 Feb

Posted by Shyam as Opinions

We all have heard about stock splits and about companies declaring bonus as well as of share buy-back. But actually these terms aren’t much clear to us. What happens when they occur? What are its tax implications? Let’s discuss each of them in detail.

Stock split

Stock splits are normally declared by company to make the share prices of the particular stock more volatile as well as affordable to the investors at large. In case of stock split both the capital and net worth of the company remains the unchanged. Here the share price adjusts proportionately to the split ratio. Consider a simple example, Tata motors declared stock split in the ratio of 1:5, the current price is Rs. 1000. Post split the share price would be trading at one-fifth the price of previous day’s price, i: e, Rs. 200 and you will be having five times the number of shares you were previously holding. How the share price of Tata motors becomes affordable to average investor, which will directly make the price more liquid.

Stock split doesn’t lead to any tax implications, just because the total cost remains the same. Considering the split of Tata motors, suppose you own 100 shares before split, making total cost at Rs. 1, 00,000(1000*100). However post split, the total cost will be Rs. 1, 00,000(200*500).

Bonus issue

Bonus shares are issued with no cost to the share holder of the company. A company declaring bonus indicates its strength and a positive sign towards its success and future prospects. This consequently surges the price of the shares due to its demand. In case of bonus issue the capital increases and conversely decreases its reserves. However, like stock split the net worth remains unchanged. The bonus issue increases the number of shares and proportionally leads to a fall in the share prices of the company thus, making no change in the personal wealth of the owner.

Since they acquired free of cost they, doesn’t attract any taxes.

Share buy-back

When the share prices of a particular company is found undervalued the company look for share buy-back option. Many a times surplus cash available with the company and having no current proposals to make any capital investment, leads to share buy-back. Few examples are Reliance, Siemens, Infosys, etc. Share buy-back boosts up EPS of a company, preventing EPS dilution. Lot many confuse, weather the amount paid for buyback can be considered as dividend or transfer of shares. If its deemed as dividend its would be tax free. However the concept was made clear, as per Finance Act 1999, when a company buys its own shares from investors then the difference between considerations received and cost of acquisition will be considered as capital gain and not dividend.