A lot of exciting things happening in the market. We seen 20% jump in the stock price of Kitex Garment yesterday! Was there any change in the fundamentals of the business?

As per available information in the market we did not find any fundamental change other than consideration of issue bonus shares and dividend to its shareholders. But is it possible for stock price to jump 20% on that news? Yesterday the volumes jumped up almost 11 times to its monthly average. We will find out more about it today as the stock exchanges had written officially to the company for explanation. So let us keep an eye on any updates from the management.

Meanwhile nothing materially has changed. We only know that the board will be considering bonus shares, which means we will see more outstanding stocks in the market. But these outstanding stocks will dilute stocks EPS (earnings per share) and book value (Equity per share).

This is something happens also when company announces stock split. The only difference between split and bonus shares is taxation. They both have different tax implication when you sell split and bonus shares. The biggest difference is the cost of acquisition. In the bonus shares it is considered as zero. While in the split the cost of acquisition is split.

But is there a big tax benefit which can explain 20% surge in the stock price?

Let us understand with the example and build up various scenarios from the shareholders perspective.

  1. Shareholder holding 100 stocks from less than a year and want to hold the stocks but cut down his/her exposure.
  2. Shareholder holding 100 stocks from less than a year and want to sell entire holding.
  3. Shareholder holding 100 stocks from less than a year and want to hold entire position.
  4. Shareholder holding 100 stocks from more than a year and want to hold entire position.
  5. Shareholder holding 100 stocks from more than a year and want to hold the stock but cut down his exposure.
  6. Shareholder holding 100 stocks from more than a year and want to sell entire position.

You could be in one of those scenarios and want to take benefit from it. Let us find out which scenario is the best as per tax implication with few assumptions.

Shareholder holding 100 stocks from less than a year and want to hold the stocks but cut down his/her exposure

 

So our basic assumption is that we bought Kitex garment stocks for Rs 400 each and we want to cut down our exposure to half. Also we are assuming that bonus ratio is 1:1.

So after bonus I will be having 200 stocks and let us assume that on ex-bonus day the stock starts trading at Rs 250. If you sell 100 stocks you will be eligible of capital loss of Rs 150 per share and you can claim Rs 15,000 as capital loss and cut down your capital gain tax liability by approximately Rs 2,250.

Shareholder holding 100 stocks from less than a year and want to sell entire holding

 

In this scenario if investor sells his/her stocks today at Rs 500 each, he will report capital gains of Rs 100 on each stock. Which means Rs 10,000 of capital gains and will be liable to pay Rs 1,500 as short term capital gain.

If he/she sells after receiving bonus stock then he will report capital loss of Rs 150 on its first 100 stocks and capital gains of Rs 250 on remaining 100 stocks. Adding both he will report same Rs 10,000 as capital gains and pay Rs 1,500 as short term capital gain.

Shareholder holding 100 stocks from less than a year and want to hold entire position

 

If you had taken a decision of holding it then there is no tax you have to pay and overall you are up by 20% on your investment.

Shareholder holding 100 stocks from more than a year and want to hold entire position

 

The same thing implies for long term investor who wants to hold and not sell any. You will be still up 20% on your investment post bonus.

Shareholder holding 100 stocks from more than a year and want to hold the stock but cut down his exposure

 

If you are in this situation than after bonus if you sell 100 stocks @ Rs 250, you still don’t have to pay any taxes as there is no long term capital gain tax.

Shareholder holding 100 stocks from more than a year and want to sell entire position

 

The best thing in this scenario will be to sell everything before bonus and save on taxes as you are holding these stocks for more than a year.

Looking at the above scenarios the most tax benefit on your investments will be not more than 5.625%. We did a bit of more in detail benefits and cannot exceed more than 9% in benefit.

You also need to understand that these are just a short term benefit and if you are the long term investor you just need to ride this wave. But not all are the long term investors.

We are happy to get more inputs and scenarios to learn more about the bonus shares. Also it is necessary to add disclaimer that we are not the accountants but if there are any accountants and see any flaw in this post we welcome you to add your input and correct us in our thought process.