All of us know that a share is a single unit of ownership in a company. A person who buys a portion of a company’s capital becomes a shareholder in that company’s assets and receives a share of the company’s profits in the form of an annual dividend. Smart investors may also reap a capital gain as the market value of the shares increases.
But, what happens when there is a company merger, bonus issue or stock split and you get ‘less’ than one share of stock, that is, one-third or one-half of a share. What are these shares called? How are they paid to you and what is their tax treatment. This article provides you information on the above mentioned questions.
A fractional share refers to unit of stock that is less than one full share. Fractional shares generally come about from stock splits, bonus shares and similar corporate actions. Fractional shares cannot be acquired from the market.
For instance: You have nine shares of XYZ Ltd that has announced a 3-for-2 stock split. In this case, you would get an extra 4.5 shares, which would be 13.5 shares total.
Normally, you can’t buy half a share in the stock market, but in this case, you could end up with a fractional share. Most companies tend to round up to the nearest whole number of shares when fractional shares occur. In the above example, XYZ Ltd could opt to round up the 0.5 share to leave you with a full 14 shares.
Fractional shares also arise when the shares held by shareholders of a company merging with another firm are unequal to the share swap (i.e. exchange) ratio fixed for the merger.
Vivek Chaurasia, senior research analyst, Personal FN, explains, “Fractional shares happen in a situation where due to a result of stock-split, company merger or bonus issue, the shares are supposed to be offered or exchanged for each share held by the investor. It may happen that the investor is holding a non-proportionate number of shares due to which he will not get the complete realisation of shares held by him. For example, I am holding 28 shares of ABC Ltd which has merged recently, and the new company (PQR Ltd) comes out with an offer to provide the stock of PQR in a proportion of say one stock for every five stocks held. In this case, I can get only five shares of the new company PQR, while the remaining three shares of the old company ABC remains with me, and then I will be eligible for a fractional share of 0.6 (3 shares / 5= 0.6) of PQR.”
Mr Chaurasia adds, “The company may however have an option to round off the 0.6 shares and may give me one full share of PQR, as the fractional share may not be bought or sold in the secondary market. If the merger offering does not has such rounding off provision, then I will make sure to buy two shares of ABC before the record date, so that I do not lose out on the market value of the remaining three shares of ABC.”
Who buys fractional shares?
Usually, the company buys the fraction shares for cash from you. The company appoints a trustee to buy the fraction shares from investors. The trustee will then pay cash for those fraction shares to the investors.
If you sell the fractional shares in the market on your own, and you have held these shares for less than a year, you’d be subjected to short term capital gains tax at 15%. If the trustee buys back your shares and pays you cash for them, you are not liable to pay any tax on it.
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