What are Bonus Shares – Types, Eligibility, Taxation and Why It is Issued
Bonus shares are additional shares provided by companies to their shareholders. They are provided based on already existing shares of the shareholders. The company’s existing shareholders are not required to pay anything to get bonus shares. The value of shares of a company decreases in the market whenever a bonus share is issued.
Bonus issues of shares are announced in ratios like 1:2, 1:4 or 2:1. For instance, an ABC company announces the issuance of 1:2 bonus shares. Every shareholder would receive 2 shares for 1 share he/she holds.
They are also known as bonus issues, capitalisation issues, scrip issues, etc.
As stated, companies’ share prices fall when they issue bonus shares. This gives a scope for new investors to invest. It also encourages retail participation, thus improving the company’s equity base.
When a company cannot pay shareholders their deserved dividend because of cash depletion, it can instead issue bonus shares. They add to the shareholders’ current holdings in the company. The bonus share acts as a reward for their participation, which encourages more investments.
By issuing bonus shares, companies capitalise on their free reserves. As they are offered against profits, the company’s profit and loss account remains unaffected while its equity base increases.
Also Read: Section 115 QA – Income Tax On Buyback Of Shares
Bonus shares are of two types:
In the case of fully paid bonus shares, no cost is charged from investors in proportion to their holdings in the company.
A fully Paid Bonus Share can be issued from:
- Profit/Loss Account
- Capital Redemption
- Investment Allowance Reserve
- Security Premium Account
For a partly paid share, the company’s stock is partially paid for and covers the entire issue price. In simple terms, an investor can purchase a share by paying for a part. However, they must pay the entire price when the company makes a call. He/she can complete the transaction by paying via instalments.
When a bonus is applied on a partly paid share and converted to a fully paid share, the bonus shares are called partly paid bonus shares.
The following are some of the unique features of bonus shares issuance.
- Companies can issue bonus shares only after the completion of 12 months of the last issue. A company can announce bonus shares only twice in 5 years.
- After a bonus share issue, a company’s liquidity increases with an increase in the number of outstanding stocks.
- Fall in share prices encourages new investors to invest.
- There are no additional taxes applicable on bonus shares.
- These do not disturb a company’s net assets as there is no cash flow.
- They encourage shareholders and investors to invest in the company in future.
- They help to strike a balance between fixed assets and shared capital of a company.
Like every other equity fund, bonus shares also come with certain merits and demerits that every investor needs to consider before investing.
1. Merits
- They are a backup plan for any company when it cannot provide dividends to shareholders.
- Liquidity of shares increases along with the number of outstanding shares.
- Acts as reward points for loyalty and participation of shareholders adding up to their existing shares.
- As a share’s value falls when a company issues bonus shares, it makes a favourable situation for new investors to invest.
- Shareholders are not taxed extra for bonus shares.
2. Demerits
- There is an accumulation of shares with shareholders when offered frequently. This brings down the cost of shares. Some shareholders may not like it.
- There is no income for the company issuing bonus shares.
- Investors expect cash or liquidity, which they receive as dividends.
- Issuing bonus shares is costlier than providing dividends.
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There is no additional tax applicable on bonus shares as the entire selling price falls under capital gains. Like other equity shares, tax implications on bonus shares are also based on the holding period. The tax implications are as follows:
- For Short-term Capital Gains (STCG): When shares are sold within 12 months of purchase, short-term capital gains are taxable at a 15% rate from a receiver.
- For Long-term Capital Gains (LTCG): When a receiver sells the shares after twelve months of purchase, it is considered Long Term Capital Gains (LTCG). If capital gains post 12 months of purchase are Rs. 1 lakh, the gains are tax-exempted. 10% tax rate is applicable without indexation for gains above this limit.
Any current shareholder of a company as of the date of announcement can receive bonus shares. The shareholder must own the shares before the ex-date and the record date. As India has a T+2 delivery system (settlement dates of security transactions that occur on a transaction date – T plus two days), one needs to purchase the shares at least two days before the record date to be eligible.
Bonus shares are allotted to a shareholder’s ISIN (International Securities Identification Number). Investors will receive their shares directly at their Demat accounts.
What is a Record Date?
The date of issuing bonus shares is termed the record date. Eligible shareholders and investors shall receive dividends or bonus shares from the company on the announced record date. The ex-date precedes the record, and one needs to pay shares before this date to be eligible for bonus shares as it takes time to get delivery of shares.
Also Read: Mutual Funds Vs Stocks: 8 Key Differences Between Stocks Vs Mutual Funds
Final Word
Companies issue bonus shares when they face cash depletion. It is not just the company’s shareholders who stand to gain but new investors too. If you are new to the trading market and looking for the right investment time, you may want to watch out for upcoming bonus shares announcements. Make sure to have a Demat account before investing.
FAQs
Ans: Companies issue bonus shares as additional shares based on the existing holdings of the shareholders. A dividend is an extra money provided by the company based on their profit. Bonus share comes to play when the company falls short of liquid cash to pay dividends to the shareholders.
Ans: In most cases, the company’s share prices fall during a bonus share issue. From a shareholder’s end, the net investments remain the same but the number of outstanding shares increases.
Ans: The stock eligible for receiving bonus shares at the announcement and record date is a cum-bonus stock. Once issued, they become ex-bonus shares as investors can no longer receive the bonus shares.
Ans: Record dates specify the cut-off period set by companies to find out eligible shareholders who would receive the bonus shares.
Ans: Conditions to issue bonus shares are as follows:
The Articles of Association of the company must authorise the bonus share issue.
The board of directors should recommend the bonus shares, which the shareholders should approve before the issue.
The company must get the consent of RBI to issue bonus shares.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
