Nykaa’s Bonus Shares! How does it affect it’s share-holders?

The decision of the Issuance of Bonus Shares by Nykaa, has largely affected some of its retail investors. Before actually deep diving into the topic – Let us first broadly understand the topic of Bonus Shares.

Bonus shares are extra shares that are issued to current owners at no additional cost based on how many shares they currently possess. These are the company's accumulated earnings that are converted into free shares rather than being distributed as dividends. Here, Nykaa issued a bonus share of 5:1. Which means, for each share – an investor would get additional 5 shares.   

The fundamental idea behind bonus shares is that the number of shares issued increases as a constant proportion of shares held to shares outstanding. Bonus shares are distributed by companies to promote retail involvement and broaden their equity base. When a company's share price is high, it is challenging for new investors to purchase stock in that specific business. The price per share decreases as the number of shares rises. But the overall capital remains the same even if bonus shares are declared.

Think of this illustration:

If you paid Rs. 1,200 for a share and the corporation announces a 5:1 bonus, it means you will now receive 5 additional shares for every share you currently own.

Do you now have 6 shares (5+1) with a value of Rs. 1,200 each? Obviously not. The stock price will decrease by a comparable amount. A stock worth Rs. 1,200 will drop to the Rs. 1,200 (1200/6) levels since you now have 6 shares for the same Rs. 1,200.

This decision of will affect the taxes of the investors while selling their holdings. How? Let us see!

Investors who purchased shares during the IPO a year ago will be affected three times more than those who made their investments earlier.

According to the calculations,

IPO investors would incur a long-term capital loss of Rs 915 and pay tax of Rs 157.50 on the gross profit of Rs 1,050 from the sale of the five bonus shares if they sold their share-holdings at Rs 210 a share on November 14.

Let's assume that you purchased one share at the IPO for Rs 1,125. After the bonus issue, you were given five additional shares, and for tax purposes, the cost of their acquisition is zero rupees. You would now record a loss of Rs 915 on the share you bought at the IPO if you sold all six shares on November 14 for Rs 210 a share, which is categorized as a long-term capital loss.

Your total gain, which would be considered short-term capital gains, for the five bonus shares would be Rs 1,050. (Rs 210 x 5). Long-term capital losses are not allowed to offset short-term capital gains under Indian tax legislation (STCG).

As a result, you would be required to pay an STCG tax of Rs 157.50, or 15%, on the profit that was actually realized. Thus, a net short-term profit of Rs 892.50 will result. Assuming there was no bonus issue, you would have sold one share on November 14th. The share price would have been Rs 1,260 (bonus not taken into account). You would have earned Rs. 135 in profit (Rs 1,260-Rs 1,125).

So basically, 1125 is the selling price of the share, which costed at Rs. 1260, which means: 1260-1125 = Rs. 135, and 10% of Rs. 135 means: 13.5 Rs. Therefore, 157-13.5 = Rs. 144.

The timing of the record date for bonus shares and the release of lock-in shares by the organization appears to be part of a two-pronged attempt to prevent a fire sale, which would cause a significant decline in the stock price.

Bonus stripping, where the ex-bonus share price hovers at levels below the cost of acquisition, may be advantageous for others, particularly private equity investors, whose acquisition prices are higher than the ex-bonus price. Bonus stripping enables one to book a capital loss and offset it against a capital gain elsewhere.

However, because the cost of acquiring the bonus shares will be treated as zero, both these private equity investors and all other shareholders will now have to pay an additional short-term capital gains tax. Previously, if these investors had sold their entire investment, they would have been subject to a 10% long-term capital gains tax. The tax rate on recent capital gains of short term is 15%. Therefore, the difference of 5% is levied.

Conclusion

Regarding whether or not this is a wise decision by the management, there are arguments on both sides at the moment.

The argument in favour is that if there is no barrier for investors to depart, there would be a crash sell, which would lower the prices. This harms investor confidence and gives the impression that stock performance is subpar.

This is the argument against. Although the action is meant to lessen the hit in terms of stock price performance, it burdens a substantial portion of shareholders in a different way.

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