Understanding Bonus Shares: Meaning, Types and Eligibility

If you are a new investor, you need to know the terms of the market. You may have heard of shares and dividends and their influence on the trading market. Similarly, the issuance of bonus shares affects a stock’s price movement, so investors should learn about it. 

Some people tend to confuse bonus shares with dividends. Although both are equity shares, these impact the company and investors’ purchasing behaviour differently. This blog will tell you all there is to know about the meaning of bonus shares, their types, advantages, disadvantages and tax implications.

What are Bonus Shares?

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.

Why do Companies Issue Bonus Shares?

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

Types of Bonus Shares

Bonus shares are of two types:

1. Fully Paid Bonus Shares

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

2. Partly Paid Bonus Shares

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.

Features of 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.

Merits and Demerits of Bonus Shares

Like every other equity fund, bonus shares also come with certain merits and demerits that every investor needs to consider before investing.

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.

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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Tax Implications on Bonus Shares

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:

1. 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.
2. 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.

Who is Eligible for Bonus Shares?

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 on Bonus Shares

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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.