Bonus shares - A shareholder's delight

1.  Introduction

One thing which every shareholder across various Companies would dream for is receipt of Bonus shares. The word “Bonus” has a very positive connotation, implying something extra or some gains at no cost.  Issue of bonus shares is the most popular way by which companies like to utilize their large accumulated reserves. Over the years of operation, most growing companies build significant accumulated profits and reserves by ploughing back profits. Sometimes, this accumulated surplus is well above company’s current and likely future operational needs. In such cases, the company finds it appropriate and desirable to reward the shareholders by utilizing retained earnings. Bonus shares are issued to the existing shareholders free of cost in proportion to their shareholding by capitalizing the amount of ‘Reserves and Surplus’. 

Bonus issue refers to a further issue of shares made by a company having share capital to its existing shareholders in proportion to their holdings without any consideration. For example Company X issue bonus shares in the ratio of 2:1. This means that for each share that an individual’s holds, the company shall provide two shares for free. If you have 100 shares on the date of record, you will get 200 shares for free; so, your total holding will now be 300. Bonus shares are not really bonuses; they are a conversion of the company’s undistributed profits into capital through issue of additional shares.

Theoretically, when the EPS reduces, the price of the share also decreases proportionately. But practically, the situation is different. With more shares in the market, the stock becomes liquid. This liquidity will lead to price discovery and identifying true and fair value of the share. Bonus issue is perceived as a good signal because the company is capable of serving a larger equity base and at the same time the net worth of the company remains intact. Shares normally trade in green after issue of bonus shares.

2. BONUS ISSUANCE – SOME RECENT CASES

‘Kothari Products Ltd.’ announced issue of bonus shares on 05 January 2016. The bonus shares will be issued in the proportion of one equity share for every two equity shares held by its shareholders. The company fixed 06 January 2016 as the record date for the purpose of issuing the bonus shares. The face value of the equity shares of the company is Rs. 10. Post the issue, the outstanding shares of the company will increase to 2,98,43,865 shares thereby increasing the total paid up capital of the company to Rs. 298.4 million.

Bharat Electronics (BEL), the public sector defence company, has approved the issue of bonus shares to the shareholders of the company in the ratio of 2:1 (2 bonus shares for every share held). The Board of directors at its meeting on July 24 also approved the proposal to increase the authorised share capital of the company to Rs 250 crore from Rs 100 crore, and consequential amendments to the memorandum of association and articles of association. The Bengaluru-based defence company reported a 2.3-time jump in the net profit at Rs 61 crore for the quarter ended June against Rs 26 crore in the corresponding quarter last year.

List of companies issuing Bonus shares in 2015

There was no specific section under the Companies Act, 1956 governing the issue of Bonus Shares. However, Section 63 of the Companies Act, 2013 read with rule 14 of the Companies (Share Capital and Debentures) Rules, 2014 have laid the turf to regulate such issuance. The provisions areapplicable to all classes of companies, listed or unlisted companies. Besides, Chapter IX of SEBI (ICDR) Regulations comprise of regulations 92 to 95also regulate issuance of bonus shares in listed companies.

3. Source for Issue of Bonus Shares:

As per Section- 63(1) a company may issue fully paid up bonus shares to its members out of following:

3.1 Free Reserves

If a Company is profit making, its accumulated profits and free reserves keep increasing. Hence profits earned appear to be much higher compared to the share capital. So it might consider that part of its accumulated profits may be distributed amongst members as bonus shares.

3.2  Securities Premium Account

In case of unlisted companies, Securities Premium amount on shares could be utilized for issuing bonus issue regardless of whether received in cash or kind. While in case of listed companies only that part of securities premium that can be realized in cash can be capitalized for issuing bonus shares. (Section 52(2)(a); 52(3)(a))

3.3  Capital Redemption Reserve Account

If preference shares are redeemed out of profits, a sum equal to the nominal value of shares so redeemed shall be transferred to the capital redemption reserve Account. The Capital redemption reserve Account shall be applied by the company towards issue of unissued shares to members of the company as fully paid bonus shares. (Section 55(4)} The capital redemption reserve created out of buy back of shares can also be utilized for bonus shares. Section 69(2)

No issue of bonus shares shall be made out of revaluation of assets. Capitalisation of profits refers to the process of converting profits or reserves into paid up share capital. A company may capitalize its profits or reserves which otherwise are available for distribution as dividend amongst members by issuing fully paid bonus shares. While the 1956 Act had permitted utilisation of the reserves arising from revaluation of assets for the purpose of issuing fully paid bonus shares.

The Company shall not issue shares in lieu of Dividend.

4.  Conditions for Issue of Bonus shares

A Company shall not capitalize its profits or reserves for the purpose of raising bonus shares unless the following conditions are satisfied.

i. Authorization in Articles.

ii. Bonus issue must be authorized by the members of the company in General meeting on recommendation of Board. The clause envisages passing of an ordinary resolution in general meeting. ICDR Regulations do not prescribe anything in this regard. As per Rule 14 of the Companies (Share capital and debentures) Rules, 2014 a company which has once announced the decision of the Board recommending a bonus issue shall not subsequently with draw the same.

Once the Board recommends, the Bonus issue cannot be withdrawn even if the members decide so. In other words you are forcing the shareholders to accept the recommendation of the Board. So it is only a formality to seek approval of the Shareholders and even if it is rejected or not passed by the members in the EGM, the company still has to go ahead with the Issue of Bonus Shares by virtue of Section 63(2)(f).

iii. Rule 12 (6) of the Companies (Prospectus and Allotment of Securities) Rules, 2014 (the Rules) requires a company to pass shareholder’s resolution for the purpose of capitalising its profits or reserves, amongst other conditions prescribed under the sub-section. Form PAS 3 deals with return of allotment of securities and therefore, allotment pursuant to issue of bonus shares under section 63 will require filing under PAS 3.

The section read with the rules nowhere requires that the shareholder’s resolution will be a special resolution, however, on perusal of the form under point 5 (e), we find that the date of “special resolution” is required. Further, such special resolution shall also be attached to the form. The anomaly is now very apparent that the provision of law does not require any special resolution, but surprisingly form PAS 3 suggests that special resolution shall be passed.

iv.  Company should not have defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it.

v. Company should not have defaulted in respect of the payment of statutory dues of the employees, such as, contribution to provident fund, gratuity and bonus.

A Company cannot issue Bonus Shares if it has defaulted in repayment of deposits, interest on deposits, debt securities, and statutory dues like, Provident fund, gratuity and Bonus. The word ‘default’ has not been defined in the Companies Act, 2013. Besides, there is no mentioning whether default should be continuing or not.

vi. Partly paid-up shares, if any outstanding on the date of allotment, should be made fully paid-up.

vii. The bonus shares shall not be issued in lieu of dividend.

5.  Capitalization of Profits

Regulation 82 of the Model Articles Table F of the 2013 Act allows Capitalisation of Profits.

i. The sum capitalised shall not be paid in cash but shall be applied either in or towards:

a) paying up any amounts for the time being unpaid on any shares held by such members respectively;(making partly paid up shares as fully paid up).

b)  paying up in full, unissued shares of the company to be allotted anddistributed, credited as fully paid-up, to and amongst such members in the proportions aforesaid;

c)  partly in the way specified in sub-clause (a) and partly in that specified in sub-clause (b)

6. Tax Treatment

Where bonus shares are issued, they become capital assets of the shareholder.  There is no tax payable on receiving bonus share from the company.  However, capital gains tax is attracted is bonus shares are sold by shareholder.  The cost of acquisition of bonus shares will be taken as ‘NIL’ for calculation of capital gains. For eg.if the shares were acquired after 01-04-1981 in accordance with section 55 of Income Tax Act.  The crucial date for the purpose of reckoning the period of holding is the date on which bonus shares were issued and not the date of purchase of original shares which gave rise to bonus shares as provided in Explanations I(f) to section 2(42A) of Income Tax Act.

7. Issue of Bonus shares by listed Companies

Chapter IX of SEBI (ICDR) Regulations comprise of regulations 92 to 95. It deals with bonus issue of listed companies.

7.1  Conditions for bonus issue (Regulation 92)

A listed issuer may issue bonus shares to its members if:

a. It is authorised by its articles of association for issue of bonus shares, capitalisation of reserves, etc. if there is no such provision in the articles of association, the issuer shall pass a resolution for authorising the same;

b. It has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;

c. It has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity and bonus;

d. The partly paid shares are made fully paid up

7.2  Restriction on Bonus Issue (Regulation 93)

i. An issuer shall not make a bonus issue of equity shares if it has outstanding fully or partly convertible debt instruments at the time of making the bonus issue, unless it has made reservation of equity shares of the same class in favour of the holders of such outstanding convertible debt instruments in proportion to the convertible part thereof.

ii. The equity shares reserved for the holders of fully or partly convertible debt instruments shall be issued at the time of conversion of such convertible debt instruments on the same terms or same proportion on which the bonus shares were issued.

7.3 Bonus Shares only against reserves, etc. if capitalised in cash. (Regulation 94)

i.  The bonus issue shall be made out of free reserves built out of the genuine profits or securities premium collected in cash only and reserves created by revaluation of fixed assets shall not be capitalised for the purpose of issuing bonus shares.

ii. the bonus share shall not be issued in lieu of dividend.

7.4  Completion of Bonus Issue (Regulation 95)

i. An issuer, announcing a bonus issue after the approval of its board of directors and not requiring shareholders’ approval for capitalisation of profits or reserves for making the bonus issue, shall implement the bonus issue within fifteen days from the date of approval of the issue by its board of directors:

Where the issuer is required to seek shareholders’ approval for capitalisation of profits or reserves for making the bonus issue, the bonus issue shall be implemented within two months from the date of the meeting of its board of directors wherein the decision to announce the bonus issue was taken subject to shareholders’ approval.

ii.The Companies Act does not prescribe any time limits for issue of bonus shares.

8. Issue of Bonus Shares to Non Resident Entity

FEMA provisions allow Indian companies to freely issue Bonus shares to existing non-resident shareholders, subject to adherence to sectoral cap, if any. However, such issue of bonus shares has to be in accordance with other laws/statutes like the Companies Act, as applicable, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (in case of listed companies), etc.

OCBs have been de-recognised as a class of investors from September 16, 2003. However bonus shares can be issued to erstwhile OCBs without the approval of RBI.

9. Reporting of Issue of Shares

i. After issue of bonus shares, the Indian company has to file Form FC-GPR, not later than 30 days from the date of issue of shares.

ii.  Issue of bonus shares or stock options to persons resident outside India, has to be reported in Form FC-GPR.

10. Listing obligations

On September 02, 2015, SEBI notified and brought the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) into effect. SEBI’s provisions for listed entities have now been aligned with the provisions of the Companies Act, 2013. The Listing Regulations finalised after consultations, will consolidate and streamline the provisions of existing listing agreements for different segments of the capital market.

The Listing Regulations shall come into force on the ninetieth day from date of publication in the official gazette i.e. 1 December 2015.

As per regulation 29 of the listing Regulations, 2015, the listed entity shall give prior intimation to stock exchange about the meeting of the board of directors in which any of the following proposals is due to be considered:

a) the proposal for declaration of bonus securities where such proposal is communicated to the board of directors of the listed entity as part of the agenda papers. However, in case the declaration of bonus by the listed entity is not on the agenda of the meeting of board of directors, prior intimation is not required to be given to the stock exchange(s).

b) As per regulation 42 of the listing Regulations, 2015, the listed entity shall intimate the record date to all the stock exchange(s) where it is listed for the following purposes:

- Issue of right or bonus shares;

- The listed entity shall recommend or declare all dividend and/or cash bonuses at least five working days (excluding the date of intimation and the record date) before the record date fixed for the purpose.

c)  The listed entity shall disclose to the Exchange(s), within 30 minutes of the closure of the meeting, held to consider the cash bonuses recommended.

11. Conclusion

While there is nothing wrong with the practice of issuing bonuses, investors' ignorance about its actual implication leads to speculative trades.This may lift the stock price in the short term.However, there is no addition to the stock's intrinsic value which is based solely on fundamentals. 

In fact, in some cases, the unscrupulous management may exploit this ignorance make such announcement to artificially inflate the stock prices. Unfortunately, for such naive investors who buy into a business hoping to gain from such corporate activities, the price is paid in the form of a loss when the hype dies down and the market once again wakes up to the long term fundamentals of the firm under consideration. As such, investors would do well not to fall for such gimmicks and base their investing decisions on fundamentals and growth prospects of a company.​