Introduction
Bonus shares are an important financial tool used by companies to distribute profits to their shareholders without affecting the company’s cash reserves. These shares are issued to existing shareholders at no additional cost, often in proportion to the shares they already own. The issuance of bonus shares helps increase the company’s equity base and can be seen as a sign of financial strength. This blog explains the concept of bonus shares under Indian company law, focusing on the relevant legal provisions and the various condition needs to keep in mind.
What Are Bonus Shares?
Bonus shares are additional shares that a company issues to its existing shareholders without any additional cost. These shares are distributed in proportion to the shareholders' current holdings. For instance, if a company declares a 1:2 bonus issue, a shareholder holding two shares will receive one additional share as a bonus. The primary purpose of issuing bonus shares is to convert a company's accumulated reserves into share capital. This process does not involve any outflow of cash, and instead, it increases the company’s equity base. Bonus shares are often seen as a way to reward shareholders and improve the company’s perceived financial strength.
Legal Provisions Governing Bonus Shares
Section 63(1) of the Companies Act permits a company to issue fully paid-up bonus shares to its shareholders. These shares can be issues out of three sources as mentioned in section 61 (1)-
- Free Reserves: These are accumulated profits that have not been distributed as dividends.
- Securities Premium Account: This account holds the amount received by the company over and above the face value of its shares during their issuance.
- Capital Redemption Reserve Account: This reserve is created when a company redeems its preference shares. The amount transferred to this reserve can be used to issue bonus shares.
The proviso to subsection (1) of Section 63 of the Companies Act, 2013, introduces an important limitation on how companies can issue bonus shares. While companies are generally allowed to issue bonus shares by converting certain reserves, such as free reserves or the securities premium account, the proviso specifically forbids using reserves created from the revaluation of assets for this purpose. In simpler terms, if a company's assets, like property or equipment, have increased in value, and this increase is recorded in the company’s books as a revaluation reserve, these reserves cannot be used to issue bonus shares.
Conditions for Issuing Bonus Shares
There are some conditions that need to be kept in mind with respect to the issuance of Bonus to the shareholders-
- The company’s Articles of Association must include a provision that allows for the issuance of bonus shares. If the Articles do not have such a provision, they must be amended.
- The Board of Directors must recommend the issuance of bonus shares, and this recommendation must be approved by the shareholders in a general meeting.
- The company must not have any outstanding defaults on payment obligations, such as interest or principal on fixed deposits or debt securities.
- The company must have not defaulted in respect of the payment of statutory dues of the employees, such as, contribution to provident fund, gratuity and bonus.
- If there are any partial paid up shares, it must be made fully paid-up shares on the date of allotment.
- The company which has once announced the decision of its Board recommending a bonus issue, shall not subsequently withdraw the same.
Restrictions on Issuing Bonus Shares
One of the key restrictions under the Companies Act, 2013, specifically mentioned in Section 63(2)(a), is that a company is prohibited from issuing bonus shares in place of paying a dividend. This means that a company cannot substitute the cash payout that shareholders are entitled to as a dividend with the issuance of additional shares. The purpose of this restriction is to ensure that shareholders receive their dividends in a liquid form, allowing them immediate access to the funds, rather than in the form of shares that might not provide the same level of financial flexibility.
Another important requirement on the issuance of bonus shares, as outlined in the Companies Act, 2013, is that bonus shares can only be issued to holders of fully paid-up shares. This means that shareholders who have not fully paid for their existing shares are not eligible to receive bonus shares. The rationale behind this restriction is to ensure that all shareholders benefiting from the bonus issue have met their financial obligations to the company.
Conclusion
Bonus shares are a significant aspect of corporate finance, providing a way for companies to distribute profits to shareholders while increasing their equity base. The process is governed by specific provisions under the Companies Act, 2013, ensuring that companies adhere to a structured approach. For shareholders and corporate professionals, understanding the legal framework surrounding bonus shares is crucial for informed decision-making and effective corporate management.