Monday, October 12, 2009

Bonus Shares:Whiten money,lighten tax bag

A little more details further to the previous post.As is clear from the previous post, the bonus shares do create capital loss for the purpose of tax calculation while no actual capital loss may have occur ed.This must not have been a big issue when our capital markets were small and ratio of Market Cap to GDP was low.Due to the fact that Reliance is the biggest publicly listed company in India,the government can potentially lose out on more than Rs20k crore of taxes due to the artificial capital losses generated by this bonus issue.To put things in perspective,this amount is about 20% of the total personal income tax receipts last year. If all the 30 sensex companies were to undertake the same exercise with their current free float market cap at 12 lakh crore rupees,this would create fake capital losses of 6lakh crore rupees which will be about twice the total direct tax collections made last year.Its bewildering to understand how Indian money in Swiss accounts gets so much attention while such big loopholes stare us. Ironically, the bonus issue is being greeted with great joy and welcomed as a gift and token of value creation.

That said,lets return to the alchemical world of converting black into white.Apart from the capital gains that are legitimate being set off against fake capital gains,one can create fake capital gains and set off them against fake capital losses. Some examples:
  1. Ram's friend Teja has accounted income in form of say salaries but unaccounted expenditure for example on foreign trips,luxury,art etc. Ram can transfer the black money in cash to Teja and Teja can buy Ram's land at inflated price thus creating fake capital gains.
  2. Ram can transfer the money abroad via Hawala or other routes which Teja can borrow, say through FIIs, to buy Ram's land.Also an NRI can also buy Ram's land through the transferred money.
  3. Ram's money need not be in India in the first place. It might already be resting in some Swiss account.A foreign entity can buy Ram's land using this money.
The possibilities are too many and time is ripe. In a reset world, returns on investment on white money are much more than black. The Noose is tightening on Swiss banks. Very many politicians/bureaucrats and other benign souls would be thanking Mr ambani for this opportunity.

Some friends have asked how can there be short terms gains taxed at 15%. Wont they get squared against the short term losses. The answer is that the bonus exercise may get stretched upto December.One can book the short term capital losses in this financial year,hedge for remaining months of this financial year and book short term capital gains in next financial year. Yes, there will be additional transaction costs besides those mentioned previously including stamp duty on land which is about 5% and brokerage costs involved in hedging which are relatively miniscule.

One does not know when and why this loophole arose in our taxation strucure but the earlier we get rid of this, the better.

PS: A related article in Business Standard by Kanu Doshi,a CA , explains that law was amended to plug this hole for mutual funds and not for stocks. The law in that case requires the units be either purchased 3 months prior to record date or be held for 9 months after the record date. Why cant law be amended to treat bonus shares at par with stock split for capital gains purposes?


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