What is a Bonus Issue?
A bonus issue (also called a scrip dividend or capitalization issue) is when a company issues free additional shares to existing shareholders in a fixed ratio. No money changes hands β the company converts its retained earnings or free reserves into equity share capital.
Unlike a stock split (which divides existing shares), a bonus issue creates new shares from the company's reserves. The practical effect for shareholders is similar, but the accounting treatment is different.
Bonus Ratio Explained
The notation works as follows:
- 1:1 bonus: For every 1 share you hold, receive 1 additional free share. Your holdings double.
- 2:1 bonus: For every 1 share, receive 2 additional shares. Holdings triple.
- 3:2 bonus: For every 2 shares, receive 3 additional. Holdings increase 2.5Γ.
Example: Hold 100 shares at βΉ300 each (total βΉ30,000). Company announces 1:1 bonus. After bonus: 200 shares at βΉ150 each (total βΉ30,000). Same total value β more shares at a lower price per share.
Where Do Bonus Shares Come From?
Bonus shares come from the company's free reserves and retained earnings β accumulated profits that have not been distributed as dividends. When a company issues a bonus, it reduces its free reserves and increases its paid-up share capital by the same amount. No cash leaves the company.
This is why bonus issues signal that a company has strong reserves β it can only issue bonus shares if it has sufficient free reserves to capitalize.
Key Dates
- Board announcement date: Board approves bonus. Share price often jumps on this news.
- Record date: Must hold shares on this date to receive bonus shares.
- Ex-bonus date: Price adjusts downward on this date. Shares bought on or after ex-date do not receive bonus.
- Allotment date: New bonus shares are allotted and credited to demat accounts (typically 15 days after record date).
Why Companies Issue Bonus Shares
- Reward loyal shareholders: Creates goodwill without cash outflow. Shareholders receive tangible benefit.
- Signal financial strength: Only companies with strong reserves can issue bonuses. It's a positive signal about earnings quality.
- Improve liquidity: More shares in circulation β more daily volume β better price discovery.
- Reduce per-share price: Makes the stock more accessible to retail investors, similar to a split.
Bonus vs Dividend β Key Differences
- Form: Bonus = additional shares. Dividend = cash payment.
- Cash flow: Bonus requires no cash from company. Dividend requires actual cash outflow.
- Tax: Dividend is taxable as income at slab rate immediately. Bonus shares are not taxed at receipt β tax only applies when you sell them (as capital gains).
- Signal: Bonus signals strong reserves. Dividend signals strong cash generation.
Tax on Bonus Shares
The cost of acquisition for bonus shares is considered βΉ0 (since you paid nothing for them). This means when you sell bonus shares, the entire sale price is your capital gain.
- Holding period for bonus shares: Counted from the date bonus shares are credited to your demat account.
- If held more than 12 months: LTCG at 12.5% on gains above βΉ1.25 lakh/year.
- If held 12 months or less: STCG at 20%.
This means selling bonus shares in the same year they're credited results in significantly higher tax than holding for 12+ months.
Bonus vs Stock Split
- Bonus creates new shares from reserves (reserves reduce, share capital increases).
- Stock split divides existing shares (no change to reserves or capital).
- Face value: Stays the same in a bonus issue. Changes in a stock split.
- Both result in more shares at a lower price per share β effect on shareholders is similar.