Bonus shares are additional shares offered by a company to its existing shareholders as “BONUS” in situations when it is unable to pay out dividends despite fetching good earnings for a quarter. The right to issue bonus shares to shareholders lies only with the company and it may decide to issue the same after having earned large profits or accumulate large amounts of free reserves that cannot be immediately utilized or cannot be distributed as dividends.
Bonus shares come in two types: fully paid and partly paid.
Fully paid bonus shares are issued to investors at no cost, based on their holdings in the company, and can come from sources such as profit/loss accounts, capital redemption, investment allowance reserve, and security premium accounts.
Partly paid bonus shares require partial payment for the stock, with the remaining balance to be paid in instalments when the company makes a call. When partly paid bonus shares are converted to fully paid shares, they are known as partly paid bonus shares.
Bonus shares are offered to shareholders based on their existing stake in the company. For instance, if a company declares one for two bonus shares, it means that an existing shareholder may get two extra shares for one existing share. Thus, if a shareholder holds 2,000 shares of the company and the company declares bonus shares, he/she will get 1000 bonus shares, calculated as (2000 *1/2 = 1,000).
A bonus share issue is a part of a company’s corporate actions and is often used for revamping its existing cash reserves. It helps in bringing the employed capital of the company in line with the issued capital. In case a company earns profit, it increases the employed capital and the same can be distributed by increasing the number of issued shares, also called issued capital.
Bonus share issues can impact a company’s Earning per Share (EPS). EPS is calculated by dividing the company’s net profit by the number of outstanding shares. A reduced EPS due to a bonus share issue is, however, compensated in the long-run by a corresponding increase in the number of outstanding shares.
A bonus share issue showcases that a company has a sound financial health. It reflects that the company is financially strong to issue more equities and has made profits.
What are the eligibility criteria for bonus issue?
Once a bonus issue is announced, a company will simultaneously announce the date of bonus share issuance. This is also known as the record date. All existing shareholders of the company, as on the record date, are eligible to get bonus shares.
The terms ‘Cum-Bonus’ and ‘Ex-Bonus’ are also related to bonus shares issue. The bonus shares that fall between the bonus issue announcement date and record date are known as ‘Cum-Bonus’. The status of bonus shares after issuance on the record date is known as ‘Ex-Issue.’
Every investor who is looking to fetch bonus shares from an issue must understand the tax implications of the same. As per the Income Tax Act, 1961, there are no tax implications on a bonus issue from a shareholder’s perspective. This means that an investor does not have to pay taxes for receiving bonus shares. However, with regards to the gains, if any, generated from trading of the additional shares are called capital gains and are taxed accordingly.
Here are some of the main benefits of bonus shares for investors:
- Investors do not incur any tax expense while receiving bonus shares.
- Bonus shares are beneficial, especially for long-term shareholders of the company who aim to multiply their investment.
- Bonus shares come free of cost for shareholders since these are issued by the company. It increases the total number of outstanding shares of an investor in the company and thereby enhances the stock’s liquidity.
- Bonus shares can build investor trust in the company’s business and functioning since they have invested in the company and are getting additional capital for free.
From a company’s perspective, some of the benefits of bonus shares are:
- Bonus shares issue enhances a company’s value and image in the market. A company can gain the trust of existing shareholders and attract more investors from the market.
- Companies can have additional free-floating shares through a bonus shares issue.
- Bonus shares issue benefits companies as they can come out of situations in which they are not able to pay cash dividends to shareholders.
Bonus shares are calculated based on the company’s accumulated profits, reserves, and surplus. The bonus share ratio determines the number of shares that a shareholder will receive as a bonus for every share held. For example, if a company declares a bonus share ratio of 1:1, a shareholder holding 100 shares will receive an additional 100 shares as a bonus.
To calculate the bonus share ratio, the company first determines the total number of shares outstanding, including those held by the promoter, institutional investors, and retail investors. Then, the company decides on the percentage of bonus shares to be issued based on the available reserves and accumulated profits. The bonus share ratio is determined by dividing the total number of shares outstanding by the number of bonus shares to be issued.
For example, if a company has 10 million shares outstanding and decides to issue 1 million bonus shares, the bonus share ratio would be 1:10, meaning that shareholders would receive one bonus share for every ten shares held.
Conclusion
A company can issue bonus shares to its shareholders to distribute its additional earnings. A bonus issue strengthens a company’s equity base and also increases the retail participation in the company’s shares. Investor’s gain when a company announces a bonus issue. Thus, the bonus issue is a win-win for both companies and investors.
FAQs
A bonus share issue does not impact the net assets of a company. It does not involve any cash flow. It simply means that the number of shares issued by the company–called share capital–has increased.
A bonus issue involves existing shareholders being granted additional shares. A stock split, however, is when an already outstanding share is divided into two or more shares as per the split ratio. Existing shareholders’ gain from bonus shares and stock splits can benefit existing as well as new shareholders.
Shareholders can sell the bonus shares as per their liquidity needs, just like any other share.
No, bonus share issue does not impact the face value of outstanding shares.
Bonus shares are issued by companies that have high reserves and do not have any fresh avenue for investment.
