Bonus Shares means additional shares given by the company to existing shareholders, that too free of cost. Shareholders can transact the bonus shares in the secondary markets. When the company is not in a position to pay dividend in cash, in situations of cash crunch despite profitable turnover then the company decides to issue bonus shares. It is issued in proportion to the shares and dividends held by the Shareholder.
Bonus is based on the number of number of shares held by the Shareholder. The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding.
Why Companies Issue Bonus Shares?
- Companies issue bonus shares to encourage retail participation. Also it increases equity base. Company chooses to provide pre-existing shareholders with bonus shares in certain situations where it is not able to pay dividends.
- Issuing bonus shares to the existing shareholders is also called capitalization of profits because it is given out of the profits of the company.
Who is Eligible for Bonus Shares?
- The Eligibility of bonus shares depends on the record date and ex-date of the shareholders. The delivery of shares in to Demat account takes place two days after the trading date and so all existing shareholders before the ex-date and record date are eligible to receive bonus shares.
- In order to qualify for the bonus shares the company stocks must be bought before the ex-date. Stocks bought on ex-date shall not be eligible for an issue of bonus shares as the ownership of the stocks cannot be gained by the investor before the record date.
What is Record Date?
- Record Date or cut-off date is the day on which a company finalizes its list of shareholders who are eligible for its forthcoming dividend distribution. Record date plays a critical role in determining the aforesaid eligibility for the dividend.
- The list of shareholders whose names are mentioned in the company’s shareholder record as on the record day are entitled to earn dividends or distribution as announced by the companies. Shareholders whose name are mentioned in the list after the record date are not eligible for dividend distribution.
What is Ex Date?
- A new buyer of the shares of a company that declared a dividend will become ineligible to receive the said dividends, if the buyer purchases the shares on or after the ex-dividend date. Therefore the ex-dividend date is essentially a cut-off date that is used by the companies to simplify their task of identifying shareholders eligible for receiving the dividend.
- It is essential to purchase the shares before the ex-dividend date to make sure you receive the dividend.
Bonus Shares Calculation?
Bonus shares are given to existing shareholders according to their stake in that particular company. For example a company which declares one for two bonus shares would mean that an existing shareholder would get one bonus share of the company for every two shares held. Suppose the shareholder holds 1000 shares of the company , now the company will issue bonus shares 1000* ½ = 500 shares
Conditions for Issue of Bonus Shares
There are few conditions that companies must meet in order to issue bonus shares. The most important conditions are
- Bonus shares in India may not be distributed without dividends
- A company cannot pay bonus shares until partly paid up shares are converted to fully paid up shares.
- Bonus shares are constructed using free reserves and share premiums. This includes investment allowance reserves but does not have capital reserves related to asset reevaluation.
- The issue of bonus shares cannot exceed paid up capital at any time.
- Companies are allowed to issue bonus shares once a year.
- The shareholders of the company must approve the proposal of issuance of bonus shares. This approval should be made well in advance of issuing bonus shares.
- The rates on dividends of bonus shares should be announced earlier to issuing bonus shares.
- Moreover a company intending to issue a bonus share should not be a defaulter in any type of loan. All payments including dues to employees and creditors should be cleared before issuing bonus shares.
- The maximum ratio of issuing bonus is 1:1 which means that a company cannot exceed the limit of one bonus share with one original and previously issued share.
The companies may, however, issue bonus shares with a lower ratio. There are two criteria associated with the ratio that must be followed while issuing a bonus share:
- Residual Reserve Criterion−This criterion requires the reserve left after bonus issues should be at least 40% of the total capitalized value of paid-up capital. Redemption and capital reserves are not counted. Investment reserve is included while calculating the residual reserve criterion.
- Profitability Criterion− It requires that 30% of the previous year’s profit before tax must be equal to 10% of the increased paid-up capital. This means the company should invest at least 30% of the previous year’s profit as 10% of the bonus share capital. In simpler words, the company’s profits must be enough to pay the bonus shares to its existing shareholders.
Types of Bonus Shares
Below mentioned are the Types of Bonus Shares
- Fully Paid Bonus Shares
No cost is charged from the investors in proportion to their holdings in the company. A fully paid bonus shares can be issued from
- Profit/Loss Account
- Capital Redemption
- Investment Allowance Reserve
- Security Premium Account
In case of Fully Paid Bonus Shares
- 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. When a bonus is applied on a partly paid shares and converted to a fully paid share , the bonus shares are called partly paid bonus shares.
Features of Bonus Shares
- Issue of bonus shares promotes the goodwill of the company among the shareholders and possible investors
- There is no change in the shareholding pattern post a bonus issue as the allotment of bonus shares is done pro-rata.
- Since the company’s share price falls considerably post a bonus issue, it provides an opportunity for the retail investors.
- After the bonus issue, the share’s liquidity gets a push by the increased number of outstanding shares.
- Bonus shares can be only issued once a period for
- 12months has elapsed since the last issue for consideration. Also only two bonus issues are followed in five years.
Advantages of Bonus Shares
- Bonus shares increase the issued share capital of the company, making it look like an attractive option to investors.
- On the market side, bonus shares provide additional income to shareholders and there is no need for investors to pay any tax on receiving bonus shares.
- Additional shares in the market lower the price per share, making it affordable to more investors.
Disadvantages of Bonus Shares
- Issuing bonus shares is costlier than declaring the dividend. It uses the company’s capital reserve.
- The corporation, on the other hand, receives no income from the release of bonus shares.
- Additional shares reduce income per share, which might disappoint investors, making the stocks less attractive.
Conclusion
- Bonus shares have certain shortcomings in the short run, due to the stock price dips and tax implications. But in the long run bonus shares will bring multifold returns.
- Long Term or Portfolio investors should mainly keep an eye on the companies issuing bonus shares. They are cash cow for both the issuing company and the shareholders.
- If the bonus shares are sold after holding them for 12 month a long term capital gain arises which is taxable at 10%. However when shares are sold within 12 month from the date of credit to respective demat accounts, short term capital gain is realized. STCG is taxable in the hands of the receiver at 15%.
- Bonus shares have ample of advantages so stockholders should be excited to avail them.
