What are bonus shares?
If authorised by its articles, a company may resolve to use any undistributed profits, or any sum credited to the company’s ‘share premium account’ or ‘capital redemption reserve’ to finance an issue of wholly or partly paid up 'bonus' shares to the members in proportion to their existing holdings. The shareholders to whom the shares are issued pay nothing. Since the issue may reduce the amount of money available for paying dividends, the term 'bonus' is not always appropriate. The correct term is 'capitalisation of reserves' or ‘capitalisation of profits’ but the terms 'scrip -' or ' scrip - issue' are also used to describe such shares.
A company can also use a capitalisation of profits to credit partly paid shares with further amounts to make them paid up.
The allotment of bonus shares must be notified to Companies House on Form 88(2). The amount paid or due on each share is ‘nil’or ‘0.00’ and the shares are shown as paid up ‘otherwise than in cash’.
In addition, if a listed public company issues bonus shares in respect of shares held in treasury, the company must notify Companies House on Form 169(1B). Stamp duty is not payable. No fee is payable to Companies House.
Issuance of bonus shares & declaration of bonus ratio
The number of additional shares to be allotted depends on the ratio of bonus declared by the Company. Bonus shares are issued out of the existing accumulated free reserves of the company.
After the shares become 'ex-bonus' the share prices adjust in the bonus ratio so that it reflects the actual situation on the ground. After the price is adjusted, investors will be ineligible for the actual bonus shares. Usually, there is a time when there might be a no-delivery period on the stock exchanges. On the date the shares go ex-bonus, the price of the share corrects in the market.
For example, a share with a price of Rs 300 will become Rs 100 in the case of a bonus issue in the ratio of 1 : 2. It takes some time for the shares to be credited to the investor's account. During this time interval, the value of the portfolio of shareholders decreases. This continues till the bonus shares are credited into the account of the investor.
The value of their portfolio goes down temporarily. Moreover, till the time the new shares come into the account, there is nothing that the investor can do about trading in these shares. That part of the portfolio is not accessible for the intervening period. The investor needs to be very careful because selling shares without their being in the de-mat account can cause problems.
After the issue of the bonus shares, the number of floating stock increases, i.e. the number of equity shares in the market. So, the market value of the equity shares goes down. However, this may not be in the same proportion. As such, it is not necessary that the wealth of the investor increases as and when the bonus shares are issued to the investors. The investor's wealth may remain same as before, the only difference being that the investor now holds more number of equity shares than he did before the issue and allotment of the bonus shares.
Based on the financials and the accumulated reserves of the company, the board of directors announce a bonus ratio. They then proceed to undertake compliance with the necessary legal requirements to complete the process. For example, if the bonus shares are issued in a ratio of 1: 2, it means that one share would be allotted for every two shares already held in the company. The record date is fixed and announced to the investors and the Stock Exchanges. The shareholders holding shares of the company on the record date are entitled to the bonus shares.
Bonus shares offer big tax benefits
With big technology and pharma companies announcing bonus share issues, it's time to reveal a secret: Bonus shares can be effectively used a tax saving tool.
How is this done? Simply, the loss incurred after selling a stock once it turns ex-bonus can be used to set off against short-term capital gains.
Bimal Doshi, Mumbai-based chartered accountant and management consultant, explains how shares of the company which announces bonus shares can be effectively used as a tool of tax planning.
As per the Income Tax Act, the cost of acquisition of bonus shares is taken at NIL, while cost of original shares remains at the cost at which there were purchased i.e. cum-bonus price. How effectively tax can be saved is explained by the following example.
Suppose short-term capital gain realised by an individual is Rs 200,000. An individual also has other income amounting to Rs 1,50,000 on which deduction under Section 80l is not available.
Further assume that you have fully invested for all tax planning investments like 10,000 for 80CCC, Rs 1.00.000 for section 88, etc.
In such case tax liability works out as follows:
Suppose, the individual intends to by a stock which he will hold for a longer period. He may look for a scrip in which bonus is issued.
Take, for example, Infosys, which announced a bonus in the ratio of 3 shares for one held. If the investor buys Infosys shares, say at a cum-bonus price of Rs 5,400 per share.
The ex-price of the share will work out to Rs 1,350 share. The investor can sell the original shares purchased at the ex-bonus price and incur taxable short-term capital loss, which he can set-off against his taxable STG.
Now suppose the investor buys 50 shares of Infosys at cum-bonus price of Rs 5,400 per share. He will receive 150 bonus shares on the original 50 shares at NIL cost.
The ex-bonus price will work out to Rs 1,350 per share. If the investor sells original 50 shares which he had purchased at Rs 5,400 per share at Rs 1,350 per share, thereby incurring total loss of Rs 2,02,500. Thus his tax liability shall work out as follows:
Thus, effective tax outflow can be reduced to the extent of Rs 59,000. The investor will have 150 shares of Infosys at cost NIL value. He may hold the same for a period of one year and take advantage of the long-term capital gain too.
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