Let's understand the tax implications when ETF units are split or when there is an issue of bonus units
Exchange-traded funds (ETFs) are a basket of stocks that trades just like an individual company's stock. An ETF usually tracks an index, such as the Nifty or the Sensex. So for that purpose, an ETF is available/traded in units on the stock exchange.
Like stocks, even equity ETFs can undergo a split, or there is a bonus issue which alters the number of units held by the investor. In both scenarios, (bonus or split) the investors end up with higher number of units of the ETF than they had originally purchased.
While there are no tax implications at the time of the allotment, investors often get confused about the tax treatment of ETFs while calculating capital gains tax at the time of selling. Well, it remains exactly the same as in the case of a stock split or a bonus issue in the case of any stock which you might have bought directly. Here is how they are treated.
Tax implications in case of a stock split
As the name suggests, it is simply breaking one unit into two or more units. For example, if a unit or a stock is split in the ratio of 1:2, it means that for every one unit/stock held, the investor will now have two. For example, if you invested in 100 units on January 1, 2021 and a split of 1:2 was announced on April 1, 2021, you will then have 200 units.
But nothing much changes from an investment point of view for the investor of the ETF. For the purpose of capital gains tax, the cost of purchase is proportionately divided between all the units. In this example, let's say you had purchased the original 100 units at Rs 15 per unit. Now while calculating the capital gains, the cost of acquisition would be Rs 7.5 per unit (Rs 1,500 divided by 200 units). Likewise, for the purpose of calculating the holding period, the original date of purchase (January 1, 2021) will be considered even for the units that were allotted after the split.
In case of an equity ETF, the capital gains on selling units after a year are taxed at 10 per cent. However, gains up to Rs 1 lakh are exempted every financial year. If they are sold within a year, the gains are taxed at 15 per cent without any exemption.
Is the tax treatment same in case of a bonus issue?
A bonus issue means that the investor will get additional shares/units at zero cost in a certain ratio. Bonus units issued in case of an ETF is rare, but one cannot rule out the possibility completely. If the ratio is 1:1, this would mean that anyone who holds one equity share/unit will now get one more at zero cost. So, continuing the above example, anyone holding 100 units will now have 200 units - 100 were originally purchased and 100 were allotted as a bonus in April 2021.
In this case, while the cost of purchase for the original purchased units/shares will continue to be at Rs 15, the cost of purchase for the bonus shares/units will be treated as zero. The whole of their sale value will be taxed. Additionally, for calculating the period of holding, there will be two separate dates of purchase. For the one originally purchased, it will January 1, 2021 (when they were actually purchased), and for the bonus issues, it will be the date of actual allotment, say April 1 for the above example.
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