Bonus units in mutual funds — tax treatment

Bonus units in mutual funds — extra units allotted to existing holders, usually one-for-one or two-for-one — are less common than in the equity world but they do happen, particularly in connection with scheme restructuring or as a way for the AMC to bring NAV back into a manageable range. The tax treatment differs significantly from dividends or rights issues.

How bonus units work mechanically

The bonus issue scales the unit count up and the NAV proportionally down, leaving the total holding value unchanged at the moment of bonus. For a 1:1 bonus on a holding of 1000 units at NAV ₹500:

• Pre-bonus: 1000 units × ₹500 = ₹5,00,000.
• Post-bonus: 2000 units × ₹250 = ₹5,00,000.

So the bonus is value-neutral at the moment of issue. The tax treatment, however, creates a wrinkle worth understanding.

Cost basis of bonus units

Section 55(2)(aa)(iiia) of the Income Tax Act treats bonus units as having a cost of acquisition of zero. The original units retain their original cost basis; the bonus units get zero.

In the example above, after the bonus:

• Original 1000 units: cost basis remains at the original purchase price (say ₹3,00,000 for 1000 units bought at ₹300 each).
• Bonus 1000 units: cost basis = ₹0.

When you eventually redeem, the FIFO rule applies separately to each group based on the date of issue. The original 1000 units are deemed sold first (if older); bonus units are sold based on their issue date.

Holding period for bonus units

The bonus units have their own acquisition date — the date of issue. Their LTCG / STCG classification starts from that date, not from the original purchase. For equity mutual funds, bonus units issued today need to be held 12 months before they qualify as long-term.

Worked tax example

Original 1000 units bought 1 January 2020 at ₹300 NAV: total cost ₹3,00,000.

1:1 bonus issued 1 January 2024: now hold 2000 units. NAV post-bonus ₹250.

Redeem all 2000 units on 1 February 2026 when NAV is ₹300:

• Sale proceeds: 2000 × ₹300 = ₹6,00,000.
• Original 1000 units sold first (FIFO). Original cost ₹3,00,000. Sale value 1000 × ₹300 = ₹3,00,000. LTCG (held since Jan 2020, > 12 months) = ₹0.
• Bonus 1000 units sold second. Cost ₹0. Sale value 1000 × ₹300 = ₹3,00,000. LTCG (held since Jan 2024 to Feb 2026, > 12 months) = ₹3,00,000.

The bonus units carry the full ₹3,00,000 capital gain even though they were a value-neutral allocation at issue. Equity LTCG above ₹1.25 lakh is taxed at 12.5% → tax on ₹1.75 lakh of bonus-unit gain.

Tax planning around bonuses

If you receive bonus units, the timing of subsequent redemption matters:

• Redeeming bonus units within 12 months of issue: STCG at 20% on the full sale value.
• Redeeming after 12 months: LTCG at 12.5% above ₹1.25L on the full sale value.
• Continuing to hold: defers tax, increases the gain (if NAV rises further).

The zero cost basis on bonus units makes them, in effect, fully taxable on redemption. There is no tax shield from the bonus issue itself.

Bonus vs IDCW reinvestment — a comparison

Functionally, a 1:1 bonus and an IDCW reinvestment can look similar — both increase your unit count. The tax treatment differs:

• IDCW reinvestment: the dividend is treated as if paid out (taxed at slab rate or under Section 194K TDS), then the cash is "used" to buy new units at the post-IDCW NAV. The new units have a cost basis equal to the dividend amount.
• Bonus issue: no tax at issue. Bonus units have zero cost basis. Full sale value of bonus units is the eventual capital gain.

For a high-bracket investor, the tax-deferred nature of bonus units (LTCG at 12.5% later) is often preferable to IDCW reinvestment (slab-rate tax now), even though both end at similar unit positions.

Are bonus units common in Indian mutual funds?

Less common today than they were in the 2000s. Modern mutual funds rarely declare bonus units. When they do, it is typically:

• In a closed-end scheme winding down.
• As part of a scheme restructure or category alignment.
• For NAVs that have grown very high and the AMC wants to make the unit price more palatable to retail buyers (mostly cosmetic).

Equity-share bonus issues, by contrast, remain common — corporate bonuses to shareholders happen regularly. Mutual fund unit-holders rarely encounter them.

Documentation

When a bonus is declared, the AMC sends a statement showing:

• Original units and their cost basis.
• Bonus units allotted, with cost basis recorded as zero.
• Combined holding post-bonus.

Preserve this statement for the eventual capital gains computation.