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What are the conditions for the Issue of Bonus Shares?
Bonus shares are additional shares that a company issues to its existing shareholders based on their existing holding in the company. Companies normally issue Bonus shares when they are not able to pay a dividend to their shareholders due to shortage of funds. In such cases, companies issue bonus shares to their existing shareholders instead of paying dividend. Investors do not have to pay any tax on receiving the bonus shares.
Conditions for Issue of Bonus Shares
There are some conditions that the companies must meet in order to issue bonus shares. The most important conditions are usually legal in nature. In India, there are certain benchmarks that the companies must follow before they can distribute bonus shares among their shareholders.
In India, bonus shares may not be distributed without dividends.
A company cannot pay bonus shares until partly paid-up shares are converted to fully paid-up shares.
Bonus shares are constructed using free reserves and share premiums. This includes investment allowance reserves but does not have capital reserves related to asset reevaluation.
The issue of bonus shares cannot exceed paid-up capital at any time.
Companies are allowed to issue bonus shares once a year.
The shareholders of the company must approve the proposal of issuance of bonus shares. This approval should be made well in advance of issuing bonus shares.
The rates on dividends of bonus shares should be announced earlier to issuing bonus shares too.
Moreover, a company intending to issue a bonus share should not be a defaulter in any type of loan. All payments, including dues to employees and creditors, should be cleared before issuing bonus shares.
The maximum ratio of issuing bonuses is 1:1 which means that a company cannot exceed the limit of one bonus share with one original and previously issued share.
The companies may, however, issue bonus shares with a lower ratio. There are two criteria associated with the ratio that must be followed while issuing a bonus share:
Residual Reserve Criterion −This criterion requires the reserve left after bonus issues should be at least 40% of the total capitalized value of paid-up capital. Redemption and capital reserves are not counted. Investment reserve is included while calculating the residual reserve criterion.
Profitability Criterion − It requires that 30% of the previous year's profit before tax must be equal to 10% of the increased paid-up capital. This means the company should invest at least 30% of the previous year’s profit as 10% of the bonus share capital. In simpler words, the company’s profits must be enough to pay the bonus shares to its existing shareholders.
Conclusion
It is easy to distribute bonus shares but since it is an important decision regarding the safety of shareholders, the legal framework for the issue of bonus shares is made stringent by the government. The rules must be followed strictly by companies issuing bonus shares which in turn help them create a favorable impression in the market and among the investors general.
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