Bonus Shares: Definition, Types, Advantages & Disadvantages

In 2018, Infosys, one of India’s leading IT companies, created headlines by announcing a 1:1 bonus share issue. Infosys has declared bonus shares 8 times since 1994.

The bonus issuance sparked excitement among its shareholders, as it indicated the company’s sustained growth and commitment to rewarding investors.

Bonus shares play a significant role in the financial markets, and understanding their dynamics can benefit both investors and companies alike.

This article will introduce the concept of what are bonus shares, their definition, purpose, and issuance criteria.

What is a Bonus Share: Definition and Purpose

Bonus shares meaning in terms of scrip dividends or capitalization issues refer to additional shares that a company issues to its existing shareholders without any cost.

These shares are typically distributed in a fixed proportion to the number of shares an investor already holds. For example, in a 1:1 bonus issue, a shareholder would receive one additional share for every share they already own.

The primary purpose of issuing bonus shares is to reward shareholders by increasing the number of shares they hold without diluting their ownership percentage.

This is achieved by capitalizing on the company’s accumulated earnings and converting a portion of its free reserves into share capital. Consequently, the company’s share capital increases while the overall value of the investment remains unchanged.

Issuance Criteria: How Companies Offer Bonus Shares

Before a company can issue bonus shares, it must meet specific criteria and follow a set process:

1. Sufficient Reserves: The company should have accumulated profits or free reserves that can be capitalized to issue bonus shares. This is essential to ensure that the company’s financial stability is not compromised.

2. Shareholders’ Approval: Companies must seek approval from their shareholders through a special resolution passed in a general meeting. The proposed bonus issue must be clearly outlined, detailing the ratio of bonus shares to existing shares.

3. Board Resolution: The company’s board of directors needs to pass a resolution approving the bonus issue, which will also include the record date for determining eligible shareholders.

4. Regulatory Compliance: Companies must adhere to the regulations set forth by the Securities and Exchange Board of India (SEBI) and other relevant authorities. This includes providing necessary disclosures, obtaining approvals, and following guidelines on lock-in periods, if applicable.

5. Record Date: The company will announce a record date to determine the shareholders eligible to receive the bonus shares. Only those who hold shares on or before the record date will receive the bonus issue.

By understanding the intricacies of bonus shares definition, investors can better comprehend their impact on the market and make informed decisions regarding their investments.

Types of Bonus Shares: Distinguishing Variants

While the primary purpose of bonus shares remains the same, they can be classified into two categories based on how they’re issued:

• Fully Paid Bonus Shares: Capitalizing on Reserves
• Partly Paid Bonus Shares: A Flexible Alternative

 

 

Fully Paid Bonus Shares: Capitalizing on Reserves

Fully paid bonus shares are the most common type of bonus shares issued by companies. They are shares issued to shareholders free of cost, capitalizing on the company’s accumulated reserves.

For instance, if a company announces a 1:1 fully paid bonus issue, it means that an investor will receive an extra share for each share they hold, at no additional cost.

These shares can provide a sense of wealth for shareholders as they increase the total number of shares held without any immediate cash outflow.

Partly Paid Bonus Shares: A Flexible Alternative

Partly paid bonus shares, on the other hand, are less common. In this case, the company issues shares to existing shareholders at a price lower than the current market price. The payment for these shares is made in installments over a specified period.

For example, if the current market price of a share is Rs. 100, a company could issue a partly paid bonus share for Rs. 50, with shareholders needing to pay the balance over time.

This offers a flexible alternative for companies looking to raise capital without immediately diluting their reserves.

Advantages of Bonus Shares: Unraveling the Benefits

Bonus shares come with a host of benefits, which can be viewed from two perspectives:

• Shareholder Perspective: Adding Value for Investors
• Corporate Advantages: Strengthening Financial Positions

Shareholder Perspective: Adding Value for Investors

From an investor’s standpoint, below are the advantages of issuing bonus shares:

• Perception of Wealth: Bonus shares increase the total number of shares held by investors, creating a perception of increased wealth. While the overall value of the investment remains unchanged, having more shares can psychologically appeal to investors.

• Increased Liquidity: Bonus shares can improve market liquidity by increasing the number of shares available for trading. This can make the stock more attractive to potential investors and facilitate buying and selling.

• Option for Additional Income: If investors need cash, they can sell the bonus shares while maintaining their original shareholding. This provides an opportunity for additional income. Open a demat account with Rupeezy today and start investing in equity shares. 

Corporate Advantages: Strengthening Financial Positions

From a corporate standpoint, bonus shares can offer a range of benefits:

• Conserving Cash: By issuing bonus shares, companies can reward their shareholders without having to pay cash dividends, thereby conserving cash for business operations or future investments.

• Enhancing Market Perception: Issuing bonus shares signals confidence in the company’s future performance, as it suggests that the company has enough reserves to expand its share capital. This can enhance the company’s market perception.

• Increasing Share Capital: Bonus issues allow companies to convert their free reserves into share capital, thereby increasing their overall share capital. This can strengthen the company’s financial position and make it more attractive to investors.

Tax Implications and Legal Aspects of Bonus Shares

As with all investment instruments, bonus shares have certain tax implications and are subject to various legal aspects.

In India, as per the Income Tax Act, bonus shares are not taxed at the time of issue. However, when a shareholder decides to sell these shares, capital gains tax will apply.

The tax rate will depend on the holding period of these shares. If sold after holding for more than a year, they are subjected to long-term capital gains tax. If sold within a year, they attract short-term capital gains tax.

Legal aspects of bonus shares include compliance with the Companies Act, 2013, and regulations prescribed by SEBI.

The company must have sufficient authorized capital, and the issue of bonus shares should be authorized by its articles of association. Furthermore, the company cannot default on any debt or interest payments.

Bonus Shares vs. Stock Dividends: Understanding the Difference

While both bonus shares and stock dividends increase an investor’s share count, they differ in several ways:

• Source of Issue: Bonus shares are issued from the company’s retained earnings or free reserves, while stock dividends are typically distributed from the company’s current earnings.

• Impact on Company’s Reserves: Bonus shares reduce the company’s reserves because they involve capitalizing part of the company’s accumulated profits. In contrast, stock dividends don’t impact the company’s reserves.

• Shareholders’ Approval: Bonus shares require approval from shareholders at a general meeting, whereas stock dividends can be declared by the board of directors without shareholders’ approval.

• Regulations: Bonus shares are regulated by SEBI in India, while stock dividends are governed by the Companies Act, 2013.

• Taxation: Both bonus shares and stock dividends have different tax implications. While bonus shares are not taxed at the time of issue, stock dividends may attract dividend distribution tax, depending on the specific regulations at the time.

 

Conclusion

Bonus shares represent a significant aspect of stock market dynamics, serving as a powerful tool for companies to reward their shareholders and strengthen their financial positions.

While they may not increase the immediate monetary value of an investment, they bring several strategic benefits, both for investors and companies.

As an investor, understanding the concept of bonus shares, their types, advantages, and tax implications is essential for effective financial planning and decision-making.

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Key Takeaways

• Bonus shares are additional shares issued to existing shareholders at no cost, capitalizing on the company’s free reserves.
• Bonus shares can be fully paid or partly paid, with the former being more common.
• Bonus shares increase the total number of shares held by investors, improving market liquidity and offering an option for additional income.
• From a corporate perspective, bonus shares can conserve cash, enhance market perception, and increase the company’s share capital.
• Bonus shares and stock dividends, while similar, have key differences in terms of their source, impact on reserves, approval requirements, regulations, and taxation.

FAQs

Q1. What is bonus share with example?

Bonus shares are additional shares given to existing shareholders at no additional cost on the basis of number of shares held by the shareholder.

For example, suppose a company announces one for two bonus shares, the shareholder will get one bonus share for every two shares held. If he/she has 100 shares, 50 bonus shares will be issued.

Q2. What happens when you get bonus shares?

When you get bonus shares, the reserves of the company reduce and share capital increases but the absolute book value remains the same.

Due to the higher number of shares now, the book value per share falls, hence the value of investment does not increase.

In the long run, bonus shares benefit the investor. As the company grows and share price also increases. 

Q3. What is the difference between bonus and split?

A bonus share is an additional share issued to existing investors from the company’s retained earnings and cash reserves. It is an alternative to paying dividends.

A stock split is simply dividing a share according to split ratio, the stock looks less expensive to investors after the split.

The liquidity also increases as a result of split. In a bonus issue, the face value of the share does not change whereas the face value also splits after a stock split. 

Q4. Which is better, bonus or dividend?

Bonus shares are issued from cash reserves and retained earning of a company, bonus share is not taxed at the time of issue whereas dividend distribution is usually from current profits and company incurs a dividend distribution tax.

A TDS is applicable on dividend income distributed by a company as per the income tax rules.

Q5. Does share price fall after bonus?

Stock price adjusts in the ratio of bonus shares issued. For example, a stock’s price is Rs 200 and bonus is issued in 1:1 ratio.

If you hold 1000 shares, the total number of shares after bonus is 2000. The total holding before bonus issue is: 100,000. The stock price after bonus is Rs 1,00,000/2000 = Rs 50. 

Q6. How bonus shares are calculated?

Bonus shares are calculated as per the ratio announced. For example, if a company declares a bonus ratio of 3:1, it means for every 3 shares held by the shareholder, 1 bonus share will be issued.

If the investor holds 3000 shares, additional 1000 shares will be issued and total shares after bonus issue will be 4000. The share price adjusts in proportion to the bonus ratio. 

Q7. Why do we get bonus shares?

Companies issue bonus shares to reward its shareholders and make the share attractive to retail investors. It also builds investor confidence in the business and its financial health.

Bonus shares are issued as an alternative to paying dividends. There is no tax on bonus share issuance whereas dividend distribution invites a Dividend Distribution Tax.