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Impact of corporate actions
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Various corporate actions have different impact on the stock prices. While the actions of the company do certainly matter, the news about the company, its fundamentals and the technical chart analysis at the time also prove a causefor the movement in company’s share prices.

However, different corporate actions have different tax implications and some of them are now used to evade taxes by the investors in the short term. A strategy gaining popularity recentlyis Bonus stripping where an investor sells shares after the announcement of a bonus and incur a loss to claim it under capital gains tax while filing income tax returns.

The concept of Bonus stripping is quite simple. Suppose you hold 100 shares of New India Assurance Limited at Rs. 618 and the company announced a split in the ratio of 1:1. Now the share price fell by almost half to Rs. 312 the next day. You get 100 more shares at no additional cost. Your position is now 200 shares at Rs. 312. In bonus stripping, the investor holding these shares sells his part – the original 100 shares at Rs.312. This implies that he incurred a loss of Rs. 316 (618-312) on his original investment on 100 shares. This sum of Rs. 31600 (316 X 100) is considered his loss and he can claim this under short term capital gain (STCG) loss if the shares were held for less than a year. This taxation loophole, even though legal, has now been plugged by the finance ministry in Budget 2018 by introducing LTCG. Government is expected to garner minimum of 15,000 cr by removing the bonus stripping clause in FY19

Advantages of Bonus stripping:

  1. The loss incurred by bonus stripping can be used to offset a capital gain but not for interest incomes. So one should be holdingbonds or liquid mutual funds for getting better tax returns.
  2. This loss can also be adjusted against any fixed deposit interest income in a year.
  3. These losses can be carried forward to 8 financial years.
  4. It proves to be a good strategy for high tax bracket investors.

Drawbacks:

  1. Investment in low quality stocks can wipe-off the entire capital itself.
  2. Strategy is not feasible during bear markets or when markets have reached peak or when markets are expected to experience some correction.
  3. One may also hold the shares after bonus announcement for more than a year to avoid STCG tax and come under long term capital gain i.e. LTCG (as the tax bracket under LTCG is less than STCG). However, the risk is high as the share prices might go down and reduce the overall return during the time period under holding.

Therefore, bonus stripping as a consistent strategy by traders needs to be done effectively in the right way considering the tax laws.

In the case of reverse stock split, which may be done by a company to boost the attractiveness of its shares with the aim of encouraging more investors to purchase the stock or to maintain its share price above a threshold level as decided by the stock exchange to avoid getting delisted.For example, when Citigroup announced reverse stock split of 1:10 shares in May 2011, the stock which was trading at $4.52 per share, began to trade above $40 per share. The stock was considered as a penny stock by the mutual funds before the split. The purpose as laid down by the then CEO was to reduce the volatility, make operationally easier for the bank to pay dividends and increase the share of institutional investors who were holding the stock.While calculating the capital gainstax, we reduce the number of outstanding shares and increase the acquisition price in the same proportion as the reverse stock split ratio.

In the case of buyback of shares, which might be done when the company has surplus reserves and no expansion plan in near future or the perceived internal return on current investments is not so attractive, the investors are liable to pay tax on account of capital gains computed by the difference between buy back price and acquisition cost. This difference arises because the company usually buyback its shares at a premium and the difference that arises proves to be the source for capital gains tax to be paid by investors.

Hence, investors need to analyse the impact of corporate actions on their total returns and choose the stocks wisely.

 

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