The perception of a stock is dependent upon the expected price movement of the stock and the company’s dividend payout policies, which can be in the form of cash dividends or stock dividends , commonly known as bonus issues. A company’s ability and willingness to pay steady dividends over time and its power to increase them reinstate investors’ faith in the stock.
Many a time, a company is not in a position to pay cash dividends, in spite of sufficient profits. In such a case, a bonus issue of shares is a powerful alternative. A bonus issue is also perceived by investors to be a strong signal by the company’s management of its readiness to service an enhanced shareholder base. The tax treatment of dividends and bonus issues are discussed below:
Cash dividend (whether interim or final) received from an Indian company is exempt from tax in the hands of the shareholder. The company paying the dividend has to pay dividend distribution tax (DDT) at the effective rate of 16.608%. Effectively, if a company has Rs 100 to distribute out of its post tax profits, the shareholders will receive a cash payout of approximately Rs 86 and the company would pay approximately Rs 14 in DDT to government.
In contrast, an issue of bonus shares on capitalisation of profits does not entail payment of any tax either for the company or its shareholders. When bonus shares are sold, the cost of such shares will be considered to be nil. If such bonus shares are held for more than 12 months and sold on a stock exchange, the capital gains are exempt from tax (subject to payment of securities transaction tax). If sold within the 12-month period, the capital gains are taxable at 15% (plus surcharge). The cost price of the original shares is not adjusted pursuant to the bonus issue.
BY Subramaniam Krishnan, Associate Director, Ernst & Young (source ET)