A bonus issue of shares is referred to as an offer of free extra shares by a company to its current shareholders. Instead of raising the dividend, a firm might elect to distribute more shares to its members. For every five shares owned, for example, a firm may offer one bonus share.
When corporations are short on cash and shareholders demand a regular income, bonus shares can be issued to shareholders. Such shares might be sold by shareholders to address their liquidity needs. Bonus shares may also be issued to help a corporation reorganize its reserves. There is no cash flow involved in issuing bonus shares. The company’s share capital is increased, but not its net assets.
A corporation can, if its Articles of Association (AOA) permit, capitalize its profits by the issue of fully-paid bonus shares.
The issuance of bonus shares by a company is a common practice. When a corporation is wealthy and earns significant distributable profits, it transforms these profits into capital and divides the capital among the existing shareholders in proportion to their entitlements. Members are not required to pay any money for these shares. They are provided for free. The bonus shares distributed to members do not constitute taxable income in their hands. But if a shareholder sells their shares, they may be subject to capital gains tax.
Moreover, the issuance of bonus shares is merely a mechanism for capitalizing undistributed earnings. The vesting of rights in bonus shares occurs when the shares are officially allotted, and not at any earlier period.
Advantages of issuing bonus shares
Internally, a bonus issue is merely a reclassification of reserves, with no net change in overall equity, despite the fact that its composition has changed. A bonus issue is an increase in the company’s share capital combined with a reduction in other reserves. Some of its benefits can be:
- Bonus shares are distributed in proportion to each shareholder’s ownership position in the firm. A bonus issue does not dilute shareholders’ equity since they are distributed to current shareholders in a fixed ratio that maintains each shareholder’s relative equity at the same level as it was before the issue.
- Since bonus shares are issued for free, a company’s fund flow is not affected adversely.
- In the long run, the market value of the members’ shareholdings usually rises as the number of shares in the firm increases.
- ‘Bonus shares’ are not considered income. As a result, it is not a taxable income.
- The paid-up share capital of a company increases with the issue of bonus shares. Because issuing bonus shares raises the firm’s issued share capital, the company seems to be larger than it is, making it more appealing to investors.
- Further, since the number of outstanding shares increases as a result of the bonus issue, it decreases the stock market price, thereby making the company’s stock more affordable to common retail investors.
What are the sources for a bonus issue?
As per Section 63(1) of the Companies Act 2013, a corporation can issue fully paid-up bonus shares to its shareholders, in any manner whatsoever, out of the following sources:
- its free reserves, or
- Securities premium account, or
- Capital redemption reserve account
However, company law specifically clarifies that the bonus issue cannot be made by capitalizing reserves out of revaluation of assets.
Note: A bonus issue is also called a scrip issue or a capitalization issue.
Conditions necessary to be complied with for a bonus issue
Section 63(2) of the Companies Act 2013 talks about certain conditions to be fulfilled for the bonus issue of shares. A company cannot capitalize its profits or reserves for the purpose of issuing fully-paid bonus shares unless it satisfies the following conditions:
1. Authorization by Articles of Association is a must. The AOA of the company must allow for a bonus issue of shares.
2. Based on the Board of Directors’ suggestion, the bonus issue should have been authorized by members in a general meeting of the company.
3. In relation to fixed deposits or debt securities issued by the company, there should not have been any default in the payment of principal or interest.
4. The company should also not have defaulted in the payment of any kind of statutory dues payable to its employees, be it PF contribution, bonus, or gratuity.
5. If on the date of allotment of a bonus issue, there are any partly paid-up shares lying outstanding in the company’s books, they must be made fully paid-up.
Further, Section 63(3) says that a company cannot issue bonus shares in lieu of a declaration of dividend. A bonus issue cannot act as a substitute for dividends to be distributed by a company.
One should also note that once a company has declared the decision of its Board recommending a bonus issue, it may not afterward withdraw it. [Rule 14 of Companies (Share Capital and Debentures) Rules, 2014]
The below-mentioned steps need to be followed when a corporation wants to issue bonus shares:
1. Check to see if the Articles of Association allow for the issuance of bonus shares. If not, update the company’s Articles of Association by passing a requisite special resolution and completing the needed process for amendment.
2. Verify if the bonus issue of shares leads to an increase in the authorized capital of the company. If it does so, make necessary alterations in the Memorandum of Association/Articles of Association by passing a necessary special resolution.
3. In the case of listed companies, give prior intimation to the stock exchange about the board meeting in which the proposal of bonus issue of shares is due to be considered. The intimation must be sent at least 2 working days in advance of the date of the Board Meeting excluding the date of intimation and the date of the meeting [Refer to Regulation 29 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015].
4. Convene a Board Meeting and take the approval of the Board of Directors on these proposals:
- The suggestion of bonus issue
- A resolution which is sought to be passed at a general meeting for seeking shareholders’ authorization on bonus issue
- The necessary resolution which is sought to be passed at a general meeting for increasing the authorized capital, if required, and effecting consequential changes in MOA/AOA
- A resolution which is sought to be passed at a general meeting for enabling the AOA to authorize the bonus issue of shares
5. Next, check that bonus shares are being issued by the corporation out of its free reserves or securities premium account, or capital redemption reserve account.
6. Verify that the issue is not being made by capitalizing reserves out of revaluation of assets.
7. Verify that the corporation has neither defaulted in the payment of principal or interest with regard to fixed deposits or debt securities issued by it nor has it defaulted in the payment of any kind of statutory dues payable to its employees, be it PF contribution, bonus, or gratuity.
8. Check that the company is not issuing bonus shares in lieu of a declaration of dividend.
9. If the company has once declared its Board’s decision to approve the bonus issue, it may not thereafter rescind that decision.
10. If on the date of allotment of bonus shares, there are any partly paid-up shares lying outstanding in the company’s books, then ensure that they must be made fully paid-up. Preferably, this should be done before the bonus issue is recommended by the Board of directors.
11. Convene the general meeting and get the special resolution(s) for the issue of bonus shares passed by the shareholders.
12. After the special resolution is passed, file Form MGT-14 along with the fees with the Registrar of Companies (ROC) within 30 days of passing of the resolution, accompanied by the altered AOA.
13. Thereafter, within 30 days of allotment of bonus shares, file a return of allotment with ROC in Form PAS-3 along with the fees in accordance with Companies (Registration of Offices and Fees), Rules 2014.
14. Deliver all share certificates to the members within 2 months from the date of allotment of bonus shares as specified under Section 56(4) of the Companies Act. For Specified IFSC public and private companies, the share certificates should be delivered within sixty days of allotment.
15. Immediately on allotment of bonus shares, intimate the details thereof to the Depository.
16. For the issue of bonus shares by listed companies, SEBI has laid down certain regulations that are contained in Chapter IX of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Ensure that these are adhered to along with the regulations prescribed under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
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