Bonus shares don’t change fundamentals of companies
Suddenly there is a spurt in issuing bonus shares by Indian companies. This year so far 73 companies have announced bonus issues and this is the second highest since 2010. In 2018, 78 companies had issued bonus shares. More than 90 companies issued bonus shares in 2010.
It is widely believed that there has been an explosive growth in corporate profits and this confidence has manifested in bonus issues. Generally market participants welcome bonus issue of shares, though on a closer look, one will understand that there cannot be any material change in the intrinsic value of a share due to bonus issue.
Bonus issue is nothing but a book entry of transferring funds from reserve account to share capital account to the extent required to issue bonus shares. It does not change the net worth of the company.
A bonus issue, also known as a scrip issue or a capitalisation issue, is an offer of free additional shares to existing shareholders. A company may indulge in issuing bonus shares instead of increasing the dividend payout. While paying a dividend, there is dividend distribution tax, whereas for the issue of bonus there is no such
taxation.
For issue of bonus shares, the company will transfer funds from its reserve account to share capital account and hence there is no outflow of funds from the company. The shareholder who gets bonus shares may sell his original number of shares or the bonus shares or both as he pleases.
For the purpose, the SEBI guidelines mandate that for issuing bonus shares, if the company is having any fully convertible debentures or partly convertible debentures, proportionate reserve of shares to such holders should be extended/reserved, while the bonus issue shall be made out of free reserves built out of the genuine profits or share premium collected in cash only.
Additionally, the reserves created by revaluation of fixed assets cannot be capitalised, while the bonus issue cannot be made unless the partly paid shares, if any, are fully paid up. Also, the company should not have defaulted in payment of interest or principal in respect of fixed deposits and interest on existing debentures or principal on redemption thereof.
The company should not have defaulted in payment of statutory dues like employees’ provident fund, gratuity, bonus, etc., while any bonus announced should be implemented within a period of six months.
While selling shares, the losses arising from such transactions will be ignored for the purpose of calculation of income for capital gain tax if investors who buy the units within a period of three months prior to the record date (date on which bonus is allotted).
If such investor sells or transfers all or any of the original units within the period of nine months after the record date, the loss will be considered as the cost of acquisition for bonus shares.
However, stock split and bonus shares are different, though they have some similarities. For example a face value of Rs 10 can be changed as face value of Re 1. So, if a shareholder is having 100 shares with face value of Rs 10, his holding will be changed as 1000 shares of face value of Re 1.
Though the number of shares is changed, there is no change in the capital or reserve of the company. Earnings per share will come down proportionately and per share market price may also come down.
(The author is a retired banker)