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Archive / Investment Adviser (Level 2) / Taxation of Equity Products
nism-series-xb-section-94-8-bonus-stripping-loss-disallowance[ INVESTMENT ADVISER (LEVEL 2) ]

Under Section 94(8) of the Income Tax Act ('Bonus Stripping'), what happens if an investor buys units within 3 months before a bonus issue, sells the original units at a loss within 9 months while retaining the bonus units?

[ A ]The bonus units are confiscated by SEBI.
[ B ]The investor is given a cash bonus by the government.
[ C ]The capital loss realized on the sale of the original units is COMPLETELY DISALLOWED and is statutorily added to the Cost of Acquisition of the retained bonus units.[ CORRECT ]
[ D ]Bonus stripping is legal and fully allowed for tax loss harvesting.
Takeaway

The correct answer is C: under Section 94(8), the loss on selling the original units within 9 months is entirely disallowed and is instead added to the cost of acquisition of the retained bonus units.

Derivation
Bonus stripping was a well-known tax-avoidance technique: buy units right before a bonus issue, watch the NAV mechanically fall after the bonus allotment, sell the original (now lower-value) units at a booked loss to offset other capital gains, while keeping the bonus units for future appreciation -- creating an artificial loss with no real economic loss. Section 94(8) neutralizes this by disallowing the loss outright whenever original units bought within 3 months before the bonus and sold within 9 months after are involved, and capitalizing that disallowed loss into the cost basis of the retained bonus units instead, deferring any tax benefit until those bonus units are eventually sold.
Why the others fail
A — The bonus units are confiscated by SEBI.
Fabricated consequence; SEBI does not confiscate bonus units -- the tax consequence is capitalization of the disallowed loss, not seizure.
B — The investor is given a cash bonus by the government.
Fabricated and false; there is no government cash bonus tied to this transaction -- Section 94(8) is a loss-disallowance anti-avoidance provision.
D — Bonus stripping is legal and fully allowed for tax loss harvesting.
Directly contradicts the statute; Section 94(8) specifically exists to disallow bonus-stripping loss claims for tax purposes, not permit them.