In my previous column I had initiated writeup on issue of Bonus shares through which I had discussed about the concept of issue of Bonus shares along with incidental aspects such as record date and ex-date, in today’s column I shall elaborate a bit more about it to gather better understanding of the same.
Reasons for issuing Bonus Shares
There could be several reasons for issue of bonus shares from the point of view of a company, like for instance Bonus shares are issued to the shareholder when the company is striving to reward the shareholders for placing trust in the management and fundamentals of the company but due to the paucity of funds are unable to provide cash dividends. Conversely Bonus shares are also issued by the company to restructure the reserves. Hence, it may deplete the reserves and increase its equity base. As issuing bonus shares to the existing shareholders are given from the profits or reserves of the company, issuing of bonus shares is also known as capitalisation of reserves. Third factor could be if a company has had exemplary quarter but due to shortage of cash it is unable to distribute the gains, despite earning huge profits. In such a case, the company will distribute the earnings in the form of bonus shares by draining the profits, instead of paying dividends. Some companies low on cash may distribute bonus shares as a method of providing a steady flow of income to the shareholders and maintain the established record of delivering returns to the investors. Also, the aim of bonus share mostly is to encourage and increase participation of retail investors as the share price decreases considerably in proportion to the allotment, and due to greater number of outstanding shares, it also increases the liquidity in the market.
Repercussions on share price
The share prices fall considerably in proportion to the allotment of bonus shares. The equity share capital remains unchanged while the number of shares outstanding increases. If a company’s share price is trading at 100, and the number of shares outstanding is 10 lakhs, so the equity share capital comes at 10 crores. In the event of distribution of bonus shares, e.g. in the ratio of 1:1, the equity share capital remains unchanged while the number of shares increases to 20 lakh as one share is allotted for every share the investor holds in the company. Hence, the price of the share decreases proportionately to Rs. 50 to accommodate the change. The impact of bonus shares on the market capitalisation is zero-sum, i.e. the market cap remains unchanged. In case of a bonus issue, the Company decides the book closure and record date to ascertain the eligible shareholders. The stock price prior to record date is termed as “Cum Bonus”, and the price after the record date is termed as “Ex-Bonus”. After the bonus issue, theoretically, the stock price gets adjusted in the ratio of bonus shares to existing equity shares.
Legal requirements for bonus issues
Bonus shares can be issued only after a period of 12 months from the issue of shares for consideration. It can be issued only out of free reserves, i.e. the reserves created out of profits realised in cash. It must be issued as Fully Paid, and only 2 bonus issues can be made in a period of 5 years. The balance of reserves after the bonus issue should work out to be 40% of the post issue capital.
Tax Implication
Under the Indian Income Tax Act, the cost of the bonus shares is considered as zero. This means that when bonus shares are sold, the entire selling price is considered as capital gains. Whether it is considered as short-term capital gains or long-term capital gains shall depend on the tenure for which the Bonus shares have been held.
If bonus shares are held for more than 12 months from the date of being credited in the demat account, in that case, they shall be considered as held for long term and the capital gains would be Long term capital gains and hence exempt from taxation up to Rs. 1 lakh above which the capital gains are taxed @10%. If bonus shares are held for less than 12 months from the date of being credited in the demat account, in that case, they shall be considered as held for short term and the capital gains would be Short term capital gains and hence 15% STCG tax would be applicable.
An astute investor is one who is not only disciplined in his financial planning but also someone who gives time for it to grow.Generally, people speculate while investing in shares and resort to panic selling as they lack belief in their scrip. Companies like Hindustan Lever Limited, Wipro and others have shown that people who have stayed true with their belief over a time have been rewarded richly not just with appreciation in the stock prices but largely from the profits they have distributed through issue of bonus shares. Which has inspired countless stories of rags to riches.