Written by Porus Confectioner, a career banker with 25 years experience in banking/ financial services and has completed the DEABL from NUJS Kolkata.

Introduction

Most Equity Share-holders look forward to a “Bonus” issue of shares, being a reward for their loyalty to the company and an opportunity to add to their wealth. Companies which have plowed back profits into accumulated reserves over many years may build up surpluses in excess of the company’s current and future operational requirements. These “ Retained Earnings “ or undistributed profits are used to issue “ Bonus Shares” to existing shareholders. The shares are issued at no cost to them and the additional shares are issued by Capitalising the amount from “Reserves and Surplus”. Capitalization of profits refers to the process of converting profits or reserves into Capital. The intent behind Bonus issue is to capitalize profits and “ bring nominal share capital in line with the true excess of assets over liabilities”.*

A Bonus Issue by a company refers to the further issue of shares to its’ existing shareholders, without consideration,  in proportion to the voting rights or pro-rata of their holding of shares in the company. Hence, none of the shareholders get diluted. A Bonus issue only raises the number of shares issued, though the Net Worth of the company remains the same. While Bonus shares may be Earnings Per Share dilutive, the additional liquidity created by the issue of additional floating stock, allows for better price discovery over time. A  1: 1 Bonus ratio means that the investor will receive one share for every share held by him.

Bonus issues are a strong success signal since the company shows the ability to service a larger equity base, add to the liquidity of the share in markets and most of all, add value to the shareholders. Additionally, there is no cash outflow in a bonus issue.

Main Discussion

Under the Earlier Companies Act 1956, there was no specific sections governing the issue of Bonus Shares. Earlier, there were norms issued by the Controller of Capital Issues which has now been abolished after the emergence of SEBI as a regulator.  The Companies Act 2013, Section 63 read with Rule 14 ( Companies Share Capital and Debenture ) Rules 2014 have encoded the law for listed and unlisted Companies. Chapter IX SEBI ( ICDR ) Regulations 92 to 95 also need to be covered for listed companies.

Conditions and Procedures

As per Section 63, (1) Bonus issue of fully paid up equity shares may be issued out of –

• Free Reserves of the company built out of genuine profits of the company ( not revaluation reserves )
• The Securities Premium Account – for listed companies the realizable cash portion of the Securities Premium Account and for unlisted companies whether in cash or others. (*Ramaiya, 17^th Ed., Part 1, Page 1255)

• Capital Redemption Reserve Account – which may be created from Buy Back of shares or redemption of preference shares out of profits, may be utilized for the issue of Bonus shares.

Notably, a company is not permitted to issue Bonus Shares in lieu of Dividend or from revaluation reserves of the company.

For a company to issue Bonus Shares the following conditions must be satisfied :

1. There should be a provision in the Articles of Association for a Bonus Issue. If not, a Special Resolution is to be passed at the General Body Meeting for the issue of Bonus shares.
2. If the subsequent Bonus issue shares exceed Authorised Share Capital of the company, A Special Resolution is to be passed at the general Body for raising the Authorised Share Capital.
3. Checks to ensure that the company has not defaulted in payment of Principal or Interest in respect of Fixed Deposits or Debt Securities or any other employee statutory dues i.e provident fund, gratuity, bonus, etc.
4. All partly paid-up shares are to be made fully paid up prior to the announcement of any Bonus Issue.
5. In accordance with SEBI (ICDR ) Regulations, the company must ensure that has outstanding fully or partly paid up are considered for the issue. Further, the issue to the holders of partly or fully convertible debentures should be converted on the same terms and proportions on which the bonus shares were issued.
6. Ordinary Resolution to be passed by the Board of Directors at Board Meeting for an issue of Bonus Shares, the decision on the ratio of share issuance and date time of General Meeting to be set.
7. Form E MGT within 30 days of Passing Board Resolution for Bonus Issue.
8. Hold General Meeting and get the resolutions for the issue of Bonus Shares passed by the members at General Body Meeting

Once the Company has announced the Bonus Issue, on authorization by the Board, it cannot be withdrawn. To put that in perspective, the shareholders are compelled to agree to the recommendations of the Board. Even at the General Meeting, shareholders will have to pass the Bonus Issue. The announcement is final and shareholder approvals are a mere formality.

1. Within 30 days of issue of Bonus Shares, file with the Registrar of allotment in Form Pas 3 along with fees as specified in Companies ( Registration of offices and Fees ) Rules.4
2. All share Certificates or allotment of share to be completed with two months from the date of allotment of Bonus issue as required under Section 56 (4), where shareholder requirements exist. The details of Allotment are to be intimated to the concerned Depositories.

Rule (12) 6 of the Companies ( Prospectus and Allotment of Securities Rules 2014 ), require form PAS 3 to be filed when such securities are allotted.

An issuer, announcing bonus, without the requirement of shareholder approvals or changes in The Articles of Association, needs to implement the Bonus issue within fifteen days from the date of approvals by Board of Directors.

For listed companies, Chapter IX of SEBI ( ICDR ) Rules, comprising Rules 92 to 95 need to be covered for Bonus issued with listed companies.  The gist of these requirements is already included in the above requirements set out.

There are no specific guidelines on the ratio of Bonus Issue.  So, companies are free to issue Bonus shares in any ratio.

Other Aspects to consider

FEMA provisions and RBI guidelines are to be adhered to in issuance of Bonus Shares to Non-Resident Indians. The company would need to check on any sectoral caps apart from Companies (ICDR) guidelines. The Issue of such shares to persons outside India has to be reported in Form FCGPR not later than 30 days from the date of issue of shares.

Listing Obligations

As per SEBI ( Listing Obligation and Disclosure Requirements ) Regulations, which came into effect on 2015, the provisions for listing have been aligned with the provisions of the existing Companies Act 2013.  As per Regulation 29 of the Listing Regulations 2015, the listed company needs to give prior notice to Stock Exchanges about the Board Meeting where the proposal for issue of Bonus shares is part of the Agenda. Also, as per Regulation 42, the listed entity needs to intimate the record date of issue of Bonus shares to the Stock Exchanges, at least 5 days before dividend or any cash bonus is declared.

Taxes 

Bonus shares, are not to be taxed on the allotment, but on sale, as decided in Sudhir Menon HUF Vs. ACIT 162 TTT 425 ( Mumbai ).  Section 56 (2) (vii) Income Tax Act does not apply to the issue of Bonus shares because there is a mere capitalization of profits by the issuing company and there is neither an increase or decrease in the wealth of the shareholder as his percentage holding remains constant. Thus, the cost of acquisition of shares to the investor in ‘Nil”. Bonus shares would be subject to capital gain tax depending on the holding period only when sold.

Note: Company law purists are still in doubt on the matter of selective issue of Bonus shares by companies. The existing Companies Act 2013 does have provisions for issue of shares with limited voting rights and hence selective bonus issues. However, there is still some doubt about whether such issue is appropriate or not, given the new legislation and the lack of precedent in the matter, though there have been instances of Selective Bonus issue in 2008 in case of Reliance Power to protect public shareholding. The selective bonus may also be permitted for listed companies to bring public share-holding in line with minimum public shareholding norms.

Conclusion

The Companies Act 1956, did not have any specific directions or rules for issue of Bonus shares by companies. The new Companies Act legislation of 2013 has included specific Section 63 and Rule 14 ( Companies ( Share Capital and Debenture Rules ) 2014 besides Chapter IX of SEBI ( ICDR ) Regulations 92 to 95, for an issue of Bonus shares by companies which has given clarity and process to the issue of these securities. While the “ Entrenchment guidelines “ have been brought into the Companies Act 2013, for protection of shareholder rights, the Rule that Bonus Shares, once recommended by the Board of Directors, cannot be withdrawn, even by shareholders at General Meeting, does appear to be at variance with the Rights of Shareholders. Further, if the Board is authorized to decide, why include a Share-holder meeting requirement, for the sake of formality? There also are some differences on reporting of resolutions as Special or Ordinary Resolution to authorities.  The new Legislation has brought a lot of clarity and procedure to the issue of Bonus shares, the experience of which is a success.

Readings

• Bare Acts: Companies Act 2013, SEBI (ICDR ) Rules 2014, SEBI ( Share Capital and Debenture Rules).
• Various articles and papers on internet.
• Discussion with Company Secretaries at various Companies