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What are bonus shares?
Free share that is given to a company’s existing shareholders is known as a bonus share. An issue of bonus shares is known as bonus issue or scrip issue or capitalization issue. These are additional shares given to shareholders without any additional cost. For example, if a company declares a 1:1 bonus issue, then every shareholder gets one share free for every share owned. So, a shareholder having 10 shares of a company will get 10 bonus shares, taking their total to 20 shares.
A bonus issue only increases the shares owned and issued; it neither increases the overall company valuation nor changes the ratio of shares that are owned by each existing shareholder. As it does not involve any cash flow, bonus issue increases only the company’s share capital and not the net assets.
Bonus shares are generally issued to restructure a company's cash reserves. As a company makes profits, its employed capital increases. This company may then issue Bonus shares to bring the issued capital in terms with the employed capital.
A bonus issue increases a company’s total shares in the market. With a 1:1 issue, a company with 1000 shares will now have additional 1000 shares issued. This takes its total to 2000 shares, thus diluting the company’s equity. After the issue of bonus shares, the Earnings Per Share(EPS = Net Profit / Number of shares) drops. However, this is then compensated by increase in the number of shares owned. In theory, an increase in the number of shares equates to drop in the share prices, but this does not always happen in reality. The bonus shares issue brings the Nominal Share Capital in sync with the excess amount of assets over company liabilities.
Bonus shares point towards the good health of a company. It implies that the company is strong enough to finance the additional equity. It shows the company’s confidence in increasing profits and servicing dividends on every increased shares.
All the existing shareholders of the company, at the time of the bonus issue, are eligible to receive bonus shares. Once the company announces a bonus issue, it also announces the date when the issue will take place. This is known as the Record Date. All the investors who are the shareholders of the company on the Record date will be issued bonus shares. Between issue announcement date and the record date, these bonus shares are known as cum-bonus. Once the bonus shares have been issued on the record date, they are known as ex-bonus.
In the Indian economy, the issue of bonus shares by companies has become common in recent years. However, to understand the tax implications an issue of bonus shares has on them, it is extremely crucial for every shareholder to learn about two very important tax provisions – (i) definition of dividend and (ii) computing capital gains for bonus issue.
(i) As per the tax laws, a dividend is the distribution of accumulated profits of a company by issuing some of its assets to the shareholders. Going by this, an issue of bonus shares to the shareholders is a form of dividend payout.
(ii)Now let’s see the case of bonus shares. To calculate the capital gains of an existing shareholder who is allotted bonus shares without any payments, the cost of these new shares is kept as zero. Even the price of the original shares does not change. As per Section 55 of The Income-Tax Act, 1961, bonus shares entail zero costs while all the purchase cost can be loaded on to the original shares. For example, if a company issues bonus equity shares in the financial year 2019-20, the shareholders face no kind of tax implication in the same financial year. When the shareholder decides to sell these bonus shares, the entire income from the sale can be taxed under capital gains. This implies that as acquiring the shares does not cost the shareholder, he does not have any tax implication for it in that financial year.
- 1.Articles of Association – A company can issue bonus shares if there is a provision for the same in the Articles of Association (AoA). In the absence of the provision, a special resolution can be passed at the company’s General Meeting to amend the Articles of Association and include the provision to issue bonus shares.
- 2.Sanction by shareholders – The bonus issue should be sanctioned by the shareholders, on the recommendation of the Board of Directors, at the General Meeting
- 3.SEBI guidelines – SEBI has laid down comprehensive guidelines regarding the issue of bonus shares in Chapter XV of SEBI (Disclosure & Investor Protection) Guidelines, 2000. Companies should ensure that they comply with all the rules and regulations while issuing bonus shares. Bonus issue should compulsorily be made out of company’s free reserves. The reserves by revaluation cannot be capitalized for a bonus issue nor should it be in lieu of a dividend. Special care should be taken that the total share capital does not exceed the authorized share capital of the company.
- 4.Outstanding Loan – In case of any loan availed from a financial institution, then prior permission has to be obtained from the institution before proceeding with the bonus issue.
- 5.Stock Exchange – In case of a listed company, the Stock Exchange should be informed of the issue immediately after it is finalized at the board meeting.
- 6.Reserve Bank – Prior consent of the exchequer i.e. Reserve Bank of India (RBI) is required if the bonus is issued to Non- Resident Indians.
- 7.Paid-up shares – Only fully paid-up bonus shares can be issued to the shareholders to protect them from the liability of amount that is uncalled on unpaid-up shares.