What are Bonus Shares?
As a new-age investor, it is vital to be aware of the fundamentals of the stock market before starting your investment journey. Along with being well-versed in the market dynamics, you must know about the key concepts of the stock markets. One such crucial aspect is knowing about corporate actions, which are the decisions taken by the companies listed on the stock exchange. These can be issuing dividend rights, split stocks and bonus shares.
In this blog, you will learn about the corporate action known as Bonus Shares.
What is a Bonus Share?
A bonus share is a free additional share given to the shareholders as a bonus. The shares are given at no additional cost based on the number of shares the investors already hold. Bonus shares are always announced in a specific ratio and results in decreasing the share price of the company with the same ratio value.
Understanding bonus shares issue
Bonus shares issues are also known as:
- Bonus issue
- Scrip issue
- Capitalisation issue
These are additional shares given to shareholders without any charges. For instance, if a company notifies 1:2 bonus issue, the shareholders are entitled to receive two additional shares for one existing share they hold. So, a shareholder with 100 existing shares will now have an additional 200 shares, bringing the total number to 300.
Implications of bonus issue:
- The bonus share issue is a corporate action to revamp the existing cash reserve of a company. It brings the employed capital of the company in sync with the issued capital. If a company makes a profit, it increases its employed capital. This surplus is distributed by increasing issued shares, also known as issued capital.
- A bonus share issue does not impact a company’s net assets as the action does not involve any cash flow. It simply means that the number of shares issued by the company – called share capital – has increased.
- Bonus share issue impacts the Earning per Share (EPS), calculated by dividing a company's net profit by the number of owned shares. However, a decrease in EPS is compensated in the long term by a corresponding increase in the number of owned shares.
- Typically, a bonus share issue underlines the sound financial health of the company. It reflects that the company is strong enough to issue additional equities and has made profits.
Eligibility for bonus issue:
- After announcing a bonus issue, a company simultaneously announces the date of the issuance of bonus shares, known as the record date. All existing shareholders on the record date are eligible to receive bonus shares.
- You must also know about the terms ‘Cum-Bonus’ and ‘Ex-Bonus’ regarding the bonus shares issued. The eligible bonus shares between the date of announcement of bonus issue and the record date are known as ‘Cum-Bonus’, while the status of bonus shares post-issuance on the record date is known as ‘Ex-Issue.’
Bonus issue and taxation:
According to the relevant provisions of the Income Tax Act, 1961, there are no tax implications on a bonus issue for shareholders in a particular financial year. This means that you don’t have to pay taxes for receiving the bonus shares. However, the gains made by trading in the additional shares are categorised as capital gains and taxed accordingly.
Bonus issue - Guidelines to be followed by companies:
Before bonus issue, the company has to follow the guidelines listed below:
- The company’s Articles of Association (AoA) must have the provision for bonus shares issue.
- The management must pass the resolution for bonus shares issued in the company’s annual general meeting. It must be recommended by the board of directors and then sanctioned by the shareholders.
- The stock exchange should be informed about the impending bonus shares issue.
- If the bonus issue is being made to Non-resident Indians (NRIs), permission is required from the Reserve Bank of India (RBI).
- The company must adhere to the exhaustive regulations prescribed by the Securities Exchange Board of India (SEBI) before the bonus issue. As per the rules, a company can only make a bonus issue from the company’s free reserves, and the total share capital cannot be more than the authorised share capital.
- The company can only issue fully paid-up shares as a bonus issue.
- If the company has availed of loans, permission is required from the particular financial institution before issuing bonus shares.
Conclusion:
A company can issue bonus shares to its shareholders to distribute its accumulated earnings. Not only does bonus issues strengthen a company’s equity base, but they also increase retail participation in its shares. As an investor, you stand to gain if the company announces a bonus issue. Before starting to invest in company shares, you must mandatorily have a Demat Account. Opening a Demat Account with a trusted financial partner like IIFL can provide access to a slew of benefits, like free AMC charges, seamless trading platforms and consolidated market research reports.