Issue Of Bonus Shares

The issue of bonus shares allows companies to capitalize accumulated profits or reserves into additional shares distributed free of cost to existing shareholders. The issue of bonus shares is governed primarily by Section 63 of the Companies Act, 2013, and the Companies (Share Capital and Debentures) Rules, 2014.

Rationale for Issuing Bonus Shares

The decision to issue bonus shares is typically driven by a company’s strong financial performance and a desire to share prosperity with its investors without depleting cash reserves. Here are the key rationales behind the issue of bonus shares:

1. Capitalization of Reserves: Bonus shares enable a company to convert its free reserves, securities premium account, or capital redemption reserve into paid-up share capital. This process does not involve any fresh inflow of funds but reallocates internal resources, enhancing the company’s equity base. It signals financial health and prudent management of profits.

2. Rewarding Shareholders: By issuing additional shares proportionally to existing holdings, companies provide value to shareholders at no extra cost. This can increase the liquidity of shares in the market, making it easier for investors to trade without diluting their ownership percentage. For instance, if a shareholder holds 100 shares and the company issues a 1:1 bonus, their holding doubles to 200 shares, though the overall value of their investment remains the same initially due to a corresponding drop in share price.

3. Preserving Cash Flows: Unlike dividends, which require cash payouts, bonus shares allow companies to retain liquidity for operational needs, expansions, or debt repayments. This is particularly beneficial during periods of growth when cash conservation is critical.

4. Enhancing Market Perception: Issuing bonus shares often boosts investor confidence, as it reflects accumulated earnings and a commitment to long-term value creation. It can also broaden the shareholder base by making shares more affordable post-issue, potentially attracting new investors.

5. Tax Efficiency: From a shareholder’s perspective, bonus shares are generally not taxable as income at the time of receipt under the Income Tax Act, 1961, though capital gains tax applies upon sale. For the company, this method avoids the dividend distribution tax that would apply to cash dividends.

However, it’s important to note that bonus shares cannot be issued from reserves created through asset revaluation, as this would artificially inflate capital without genuine profit backing.

Legal Framework under the Companies Act, 2013

Section 63 of the Companies Act, 2013, read with Rule 14 of the Companies (Share Capital and Debentures) Rules, 2014, forms the backbone of bonus share issuance. Key provisions include the following:

A. Permissible Sources: Bonus shares can only be issued from:

• Free Reserves (as defined in Section 2(43), excluding unrealized or notional gains).
• Securities Premium Account.
• Capital Redemption Reserve Account.

B. Prohibitions: No bonus shares can be issued in lieu of dividends or by capitalizing revaluation reserves.

C. Preconditions for the Issue of Bonus Shares:

• The company’s Articles of Association (AoA) must authorize the issuance.
• The board must recommend the issue, followed by approval in a general meeting through an ordinary resolution.
• The Company should not have defaulted in any payments related to fixed deposits, debt securities, or employee statutory dues (e.g., provident fund, gratuity).
• Any partly paid-up shares must be fully paid before the issue of bonus shares.

Process for Issuing Bonus Shares

The process for issuing bonus shares is methodical and requires adherence to timelines to avoid penalties. Below is a step-by-step guide applicable to both private and public companies, with additional notes for listed entities.

1. Verify Authorization and Eligibility:

• Review the AoA to confirm provisions for bonus shares. If absent, amend the AoA via a special resolution under Section 14.
• Assess available reserves through audited financial statements to determine the quantum and ratio.
• Ensure no defaults in debt repayments or statutory obligations.

2. Convene a Board Meeting:

• Convene a board meeting to discuss and approve the bonus issue proposal.
• Decide on the ratio, sources of capitalization, and record date for eligibility.
• Pass a resolution recommending the issue to shareholders.

3. Conduct a General Meeting:

• Hold an Extraordinary General Meeting (EGM).
• Pass an ordinary resolution (unless AoA specifies special) approving the bonus issue based on the board’s recommendation.
• File e-Form MGT-14 with the ROC within 30 days of the resolution.

4. Allotment of Shares and Issuance of Share Certificates:

• Allot bonus shares to eligible shareholders on the record date.
• File Form PAS-3 (Return of Allotment) with the ROC within 30 days, attaching the board and general meeting resolutions, valuation report (if required), and list of allottees.
• Update the register of members under Section 88.
• Issue physical or dematerialized share certificates within two months of allotment under Section 56.

5. Post-Issuance Compliance:

• Update statutory registers and inform depositories if shares are dematerialized.
• Reflect the capitalization in the next financial statements.