What Is Bonus Share: Meaning, Eligibility, Advantages & Types

Investing in stocks is a popular way to maximize wealth and generate income. As a stockholder, you have the right to receive dividends, which are your share of the company's profits distributed among its investors. But are you familiar with bonus shares, or know what is a bonus share?In the following article, we will explore what is meant by bonus shares and what their advantages are.

Bonus shares are additional shares offered by a company to its already existing shareholders at no extra cost. These shares are issued in proportion to the current shareholding of the investors.For example, if you own 100 equity shares of a company and it announces a bonus issue of 1:1, you will receive an additional 100 shares for free. Similarly, if that company announces a 4:1 bonus issue, you will receive four shares for every one share you hold. So for those 100 shares, you will get 400 (4 x 100) shares in total. Your total holding will rise to 200 shares in the first example, and 500 shares in the second.The total value of your investment remains the same, though the number of shares you hold increases. But what this also means is that the value of shares falls after issuance of bonus shares. Say the pre-bonus issue share price is Rs 100 a share; after the 4:1 bonus issue, this price falls to Rs 25 a share.Also, note that while an increase in the number of shares reduces the price per share, the overall capital remains the same.There is also something known as the scrip dividend; these are free shares offered in lieu of cash dividends, with shareholders having the choice of taking one or the other.

It is a specific date chosen by a company to determine which shareholders are eligible to receive bonus shares. Shareholders who hold shares in their Demat account on the record date will be entitled to receive the bonus shares from the company.

It is the day before the record date. To qualify for bonus shares, an investor must buy the shares at least one day before the ex-date. If someone buys shares on the ex-date or after, they won't be eligible to receive bonus shares.

Shareholders who own the company's shares prior to the record date and ex-date are eligible to receive the bonus shares. In India, the record date comes two days after the ex-date. To be eligible for bonus shares, shareholders should hold the shares before the ex-date. Buying shares on the ex-date or later would make them ineligible for receiving bonus shares. The bonus shares are allocated after obtaining their new ISIN, and this process usually takes about 15 days.

Here's why comapnies issue bonus shares,

1. To encourage retail participation:

When a company's stock price is high, it gets expensive for smaller investors to buy. By issuing bonus shares, the company increases the number of shares in the market, which brings down the price per share. This makes the stock affordable for retail investors, encouraging broader participation and improves liquidity in the market.

2. Reflecting sound financial health:

Issuing bonus shares indicates that the company is financially strong and profitable. It shows that the company has accumulated profits or reserves, which are being used to issue additional shares. This action gives shareholders a positive signal about the company's future prospects.

3. Rewarding shareholders:

Bonus shares act as a way to reward existing shareholders without the company having to pay out cash dividends. When a company is short on cash or wishes to retain its cash reserves, issuing bonus shares allows it to share its success with shareholders without distributing cash.

4. Positive future outlook:

When a company issues bonus shares, it suggests that the its expects to handle the increased capital easily in the future. This indirectly indicates to investors that the company has a positive outlook for its future growth.

Bonus shares can be classified into two main types: fully paid, and partially paid. Let us check out each:

1. Fully paid bonus shares:

Fully paid bonus shares are issued to existing shareholders without them paying any additional payment or having any extra obligation. The company converts its accumulated profits or reserves into new shares and distributes them proportionally among shareholders. The holding of each shareholder increases, but the overall value of their investment remains the same.

2. Partly paid bonus shares

When partly paid bonus shares are issued, the existing shareholders have to make some payment, usually in installments.Partly paid bonus shares allow companies to provide additional ownership to shareholders while also raising additional capital for the company.The payment terms and schedule for partly paid bonus shares are determined by the company and communicated to the shareholders. Also Read: What is Bonus in Equity Capital

Issuing bonus shares has several advantages, with both the company and shareholders benefiting. Let us check out what these are:

Advantages for shareholders

1. Increase in shareholding:

One of the primary advantages of bonus shares is that they increase your shareholding in the company without any additional investment. This enhances the potential for future gains for you.

2. Enhanced liquidity

Bonus shares also contribute to enhanced liquidity of the shares, as these not only increase the number of outstanding shares but also lead to the share price falling. This fall in share price makes it more attractive to investors, as they become easier to buy or sell in the market.

3. Profitability factor

When a company is making profits, chances are its stock prices will go up. This means the bonus shares spell profits for shareholders, as these can be sold in the secondary markets; as these were free, any price fetched is a profit.

4. Tax benefits

In many countries, investors are not required to pay tax on bonus shares. India is one such country where capital gains on bonus shares are exempt up to Rs. 1 lakh and after which a flat 10% is levied on LTCG.

Advantages for company

1. Signals growth

Issuing bonus shares is often seen as a positive signal about the company's financial health and growth prospects. It demonstrates it has accumulated sufficient profits to distribute among its shareholders. Such positive sentiments can attract more investors and potentially increase stock price.

2. Psychological benefit

Receiving bonus shares can also have a psychological benefit for investors. It provides a sense of ownership and participation in the company's growth, and make investors feel valued by the company. This can encourage them to hold on to their investments for the long term.

3. Dividend option

Often, companies find themselves facing a liquity crunch, which prevents them from paying cash dividends to their shareholders. To get out of that situation, they issue bonus shares in lieu of cash dividends.

4. Tax dodge option

However, companies are also known to issue bobus shares despite having ample liquidity. They do it to avoid the steep dividend distribution tax they are required to pay when declaring dividend.

Bonus shares are not to be included in the Income Tax Return filings. For tax purposes, bonus shares are considered as “Exempt Income” in case of share buybacks.When bonus shares are sold, tax is calculated considering the holding period. If the bonus shares were alloted before a certain date (e.g., January 31, 2018), the cost of the bonus share would be the stock's closing price on that date. If the bonus shares were issued after that date, the cost would be considered zero.If bonus shares are sold within a year of issuance, a flat 15% income tax is incorporated. For shares held for more than a year, any income exceeding Rs 1 lakh from the sale of bonus shares is subject to a 10% tax. The taxation is based on the First In First Out method, where the first shares bought are considered the first ones sold.

So, if you study what is bonus issue of shares, you will realize it is an attractive proposition for investors as they offer numerous advantages in terms of increasing shareholding, enhancing liquidity, and signaling a company's growth.All in all, it makes the company’s shares more appealing in the secondary market, which should be handy should a shareholders decide to offlload some of his or her stock.