Saturday, October 10, 2009

Bonus shares:Vehicle for whitening black money

RIL has recently announced a bonus share in the ratio of 1:1. RIL has a market cap of about 3 lakh crore rupees with 47% being held by promoters. On issue of the bonus shares, the shares will trade at about half their current price ex bonus.This Business Standard article from april 2004 explains in detail how Bonus shares can be used to create short term capital loss which can be set off against any capital gains.A relevant excerept from article from Income Tax Office,Banglore:
Loss from transfer of a short term Capital Asset can be set off against gain from transfer of any other capital asset(Long Term or Short Term) in the same year. Loss from transfer of a Long term Capital Asset can be set off against gain from transfer of any other long term Capital Asset in the same year.

If there is a net loss under the head “Capital Gains” for an assessment year, the same cannot be set off against any other head of income viz., Salaries, House Property, Business/Profession or Other Sources. It has to be separated into Short term Capital Loss(STCL) and Long Term Capital Loss (LTCL) and carried forward to next assessment year. In the next year, the STCL can be set off against any gains from transfer of any capital asset (Long term or Short term) and LTCL can be set off against gains from transfer of long term capital asset only. Any unabsorbed loss after such set off can be further carried forward to next assessment year.

Capital loss computed in an assessment year can be carried forward for eight assessment years and set off as above.

So lets say Mr Raju buys the RIL share before bonus and sell the original shares immediately after shares go ex-bonus to book short term capital loss. The bonus shares have a NIL cost of acquisition. Now, Raju can either sell the bonus shares and pay a short term capital gains tax @15% or he can hold the bonus shares for a year. He can hedge his risk by selling the RIL shares in forward market and keep on rolling for a year but there too there is cost of capital involved.Assuming he has to pay 25% as the margin money and cost of capital is 15%, the total cost will be 3.75%. Both of these options are much more attractive than standard 30% STCG for non equity capital assets held for less than 3 years.

Since the non promoter holding in RIL is worth about Rs 1.5 lakh crore rupees,there can be about Rs75,000 crore rupees of capital loss available for the taking.Since bulk of the money in country is in form of land,this is a very attractive option for bringing that on the books at its real price.And this is all perfectly legal. This loophole has existed for a long time but RIL being the largest Indian company in terms of Market capitalisation and the ratio of 1:1 probably makes it ptentially the biggest tax amnesty scheme so far.