Bonus Shares Before an IPO: The Short-Term Gains Trap

Key Takeaways

• Indian tax law treats a bonus share as a new asset. Its cost is nil and its holding period starts on the date of allotment.
• After a 10:1 bonus, only 1 share in 11 (about 9%) carries the original holding period. The other 91% are short-term until they cross the holding threshold.
• An IPO offer for sale or an M&A exit soon after the bonus can therefore produce mostly short-term gains on a zero cost base.
• Shares in one demat account are treated as sold first-in, first-out (FIFO), so which shares are “sold” is not a free choice.
• Several countries, such as Germany, split the original cost across the bonus shares and continue the holding period. India does not, which adds complexity for non-resident shareholders.

Why companies issue bonus shares before listing

A company preparing for an IPO often needs a lower share price. A share split can do part of the job, but in practice the face value is not taken below Re 1. Where that is not enough, the company issues bonus shares, sometimes at ratios above 10:1.

For a listed company, a bonus issue also brings liquidity and, for some investors, the false comfort of “free” shares. For a promoter, the tax result is less comfortable.

How India taxes a bonus share

Example of the arithmetic. A promoter holds 1,00,000 shares acquired years ago. The company issues 10 bonus shares for every share held. The promoter now holds 11,00,000 shares: 1,00,000 long-term shares with their original cost, and 10,00,000 bonus shares with a cost of nil and a new holding period. Only 1,00,000 / 11,00,000, or 9.1%, is long-term. Until the holding period runs, any sale above that 9.1% gives short-term gains.

Worked example: an offer for sale soon after the bonus

Continuing the example, the IPO comes 8 months after the bonus. In the offer for sale, the promoter sells 3,00,000 shares at INR 500. The original shares cost INR 10 each, and all shares are in one demat account.

Two-thirds of the gain is short-term. The tax difference depends on the rate that applies to each block at the time of sale, which the reviewer should confirm for an offer for sale. On illustrative rates of 12.5% long-term and 20% short-term, before surcharge and cess, the short-term block alone costs INR 75,00,000 more than it would have at the long-term rate (INR 10 crore x 7.5%).

The options, and their limits

There are few clean answers. KCM sees three areas to work on, each needing careful facts:

• Timing. Plan the bonus early enough that the holding period has run by the expected exit, or size the offer for sale to the long-term shares.
• Demat management. Because FIFO applies within a demat account, original and bonus shares are sometimes held in separate demat accounts so that the shares sold are identifiable. This is an operational step and must be set up before the bonus.
• Restructuring alternatives. In some cases, the share count can be raised through a merger or demerger exchange ratio instead of a bonus, or a bonus can be cancelled. Each has corporate, SEBI and tax conditions, and anti-abuse rules apply. These are not routine steps.

Points that make it more complex

• Non-resident shareholders. Countries such as Germany treat a bonus as a split of the original holding. A non-resident promoter may face different holding periods and costs in India and at home.
• Bonus preference shares. Equity shareholders can receive bonus preference shares. Their tax treatment, in India on redemption and abroad on receipt, differs by country and needs specific advice.
• Bonus stripping. A bonus issue reduces the value per share while the cost of the original shares stays the same, which can produce a loss on selling the original shares. India’s bonus stripping rule, extended to securities from 2022, disallows that loss where the shares were bought shortly before the record date and sold shortly after it, and treats it as the cost of the bonus shares. It should not be treated as a planning route.

What to do

• Model the tax on the expected IPO or exit before fixing the bonus ratio and date.
• Decide the demat structure before the bonus is allotted.
• For non-resident shareholders, check the home country’s treatment of the bonus.
• Record the commercial reason for any alternative to a bonus, such as a merger or demerger ratio.

FAQ

What is the cost of a bonus share in India?
Nil. The original shares keep their cost, and the bonus shares are treated as acquired on the allotment date at no cost.

When does a bonus share become long-term?
When it has been held for more than 12 months if it is a listed equity share, or more than 24 months if unlisted, counted from the date of allotment.

Can I choose to sell the original shares first?
Within one demat account, shares are treated as sold on a first-in, first-out basis. Separating original and bonus shares into different demat accounts before the bonus can help, but it has to be set up in advance.

Is a share split treated the same way?
No. On a split, the original cost is spread over the new shares and the holding period continues. That is why a split is usually preferred where it is enough to reach the target price.

Talk to KCM about pre-IPO tax planning: contact us.

Sources and last checked: 9 November 2026

• Income-tax Act, 2025, provisions on cost of acquisition of bonus shares, period of holding, capital gains rates and bonus stripping (corresponding to sections 2(42A), 55(2)(aa), 94(8), 111A and 112A of the 1961 Act). Section numbers under the 2025 Act to be confirmed by the reviewer.
• Originally shared on LinkedIn by Suril Mehta: https://www.linkedin.com/posts/surilm_bonus-preferenceshare-ipo-share-7416903932410671104-bf_D/

This is not to be construed as legal advice. The actual advice will depend upon the facts and will have to take into consideration the case-specific facts and the anti-abuse regulations.