Bonus Shares are the shares where the company issues additional number of shares to the existing shareholders of the company without incurring any additional cost. These are the company’s cumulative earnings that company converts into free shares rather than distributing it as dividends.
For instance, if investor A owns 200 shares of a company and the company announces a 4:1 bonus payout, he will receive 4 additional shares for free for every share he owns. His overall stake will rise to 1,000 shares after receiving a total of 800 shares for free.
Conditions and Regulations for Bonus Issue
Following are the guidelines for bonus issue as per Securities and Exchange Board of India (SEBI):
- There must be provisions in the Articles of Association of the company for the issue of these shares. If there are no such provisions in the Articles, then the company should amend its Articles before issuing these shares.
- If the subscribed and paid-up capital exceeds the authorised share capital due to the issuance of these shares, the company must pass a resolution at its general body meeting to increase the authorised capital. And also amend the capital clause of Memorandum of Association.
- Issue of shares must be within six months from the date of approval of the Board of Directors.
- The Board of Directors must recommend the bonus issue in its resolution. Additionally, the company’s shareholders should adopt this recommendation at the general meeting.
- The Company has not delayed any of the payments of interest or principal on any of its debt securities in respect of fixed deposits. It has also not delayed any payments relating to interest on existing debentures or principal on redemption thereof.
- The Company has not made any defaults regarding the payment of statutory dues of the employees such as contribution to provident fund, bonus and gratuity.
- Convert partially paid-up shares to fully paid-up shares as on the date of allotment.
- There is no declaration of a bonus issue in lieu of a dividend.
- The company should not issue these shares by utilising the reserves created by the revaluation of fixed assets.
- The company must issue these shares out of free reserves. The free reserves must be from either profits or securities premium reserves.
- No listed company shall issue shares pending conversion of FCDs/ PCDs. The company must extend a similar benefit to the FCDs/ PCDs holders by reserving shares in proportion to such convertible shares of FCDs or PCDs.
All the existing shareholders who own the company’s shares are eligible to receive these shares before the ex-date and record date. The shareholders must buy the company’s shares before the ex-date to be qualified to receive the bonus issue of shares.
The two different types of shares are as follows:-
- Fully Paid Up Bonus Shares:
Before issuing bonus shares, distribute these shares at no additional cost in proportion to the investor’s holdings in the company. The company issue these shares out of Capital Redemption Reserves, Profit and Loss Account, Investment Allowance Reserve, etc.
- Partly Paid Up Bonus Shares:
Before issuing bonus shares, the company should convert partially paid shares into fully paid shares. The company issue these shares out of Investment Allowance Reserve, General reserve, Development rebate reserve, etc.
Advantages and Disadvantages
Investor Point of View
- These shares don’t attract any taxes.
- Long-term investors can benefit from a higher number of shares.
- Issue Bonus shares at no cost to shareholders. The total number of shares an investor holds increases.
- Helps in building investors’ trust in the company.
- Since shareholders own a higher number of shares, their dividend receivables will be higher in the future.
- When the company declares a dividend in the future, the investor will receive a higher dividend because he now owns more shares in the company due to the bonus issue.
- The issue will not increase profits, as the earnings per share falls. Investors should be aware of the possibility of receiving bonus shares because the profit will remain constant, but the number of shares will increase as earnings per share fall.
Company Point of View
- These shares increase the company’s issued share capital, thus increasing liquidity and investor participation.
- With the issuance of these shares in the market, the companies have more free-floating shares.
- Companies issue these shares when they are unable or prefer not to pay cash dividends.
- The bonus issue of shares increases the company’s value and market position.
- When issuing these shares, the company does not receive any cash.
- Issuing bonus shares is more expensive than declaring a dividend. It allows the use of the capital reserve of the company.
Taxation of Bonus Issue
According to the relevant provisions of the Income Tax Act of 1961, a bonus issue for shareholders in a particular, fiscal year has no tax implications. This means you won’t have to pay taxes when you receive these shares. Capital gains arise when you trade/ sell additional shares and pay taxes accordingly.
Frequently Asked Questions
To increase equity base and encourage retail participation. When a company’s share price is high, it becomes difficult for new investors to purchase shares of that company. Therefore, the price per share decreases, the number of shares increases.
Companies with strong financial position, strong reserves, and cannot pay dividends due to cash shortage.
Yes, it enhances the value of the company. It increases the market positions and image and attracts several small investors.
A record date is a date set by the company to evaluate the existing shareholders and distribute bonus shares to them.
The ex-date is one day earlier than the record date. To be eligible for the bonus shares, an investor must purchase the shares at least one day before the ex-date.
The eligible shareholders are assigned a new ISIN number and within 15 days the shares are credited to the Demat account.
When the bonus shares are issued, the share price falls. The book value per share decreases due to an increase in the number of outstanding shares.
Yes, a dividend is paid on bonus shares.
Upon bonus share issue, the number of shares held by the shareholder increases, but the overall value of the investment remains the same.
Dividends are paid to shareholders in cash, whereas bonus issues payments are in the form of additional shares. Thus, shareholders can benefit from price appreciation in the future.
A company pays DDT on the issuance of dividends. While bonus issue is considered as new share issue.