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December 8, 2020

Bonus Shares and Right Issue as per Companies Act 2013

by CA Shivam Jaiswal in Corporate Law

Bonus Shares and Right Issue as per Companies Act 2013

Entity’s often make decisions that involve spending money in the present and expecting to earn profits in the future. For instance, when a company buys a machine that will last 10 years, or builds a new plant that will last for 30 years, or starts a research and development project. Companies can raise the financial capital they need to pay for such projects in by: (1) early-stage investors; (2) reinvesting profits; (3) borrowing through banks or bonds; and (4) selling stock. When owners of a business choose sources of financial capital, they also choose how to pay for them.

Issue of Bonus Shares

Bonus Shares are given to shareholders as some additional shares, based upon the number of shares the shareholders hold in the Company. The accumulated earnings of a company sometimes are not distributed as Dividend but are issued as Bonus Shares. These shares are issued to the current shareholders without receipt of any consideration from them. Bonus Shares increases the marketability of the Company. The main intention behind Bonus Issue is to bring the nominal capital of the Company in line with the assets.

How are bonus shares issued?

A company can issue fully paid-up bonus shares to its members out of its free reserves, the securities premium account or the capital redemption reserve account. However, no issue of bonus shares shall be made by capitalizing reserves created by the revaluation of assets. Also no bonus shares shall be issued in lieu of dividend.

Who is ineligible to issue bonus shares?

The following companies are ineligible to issue bonus shares:

  • A Company who has defaulted in repayment of deposit.
  • A Company who has defaulted deposit interest.
  • A Company who has defaulted in debt securities.
  • A Company who has defaulted in respect of payment of statutory dues of the employee’s viz., contribution to Provident Fund, Bonus and Gratuity.
  • A Company who has any unpaid outstanding partly paid shares

What are the pre-requisite conditions to issue bonus shares?

  • The issue of bonus shares must be authorized by the Articles of the company.
  • The issue of bonus shares must be recommended by the resolution of the Board of Directors.
  • This recommendation must be later approved by the shareholders of the company in the general meeting.
  • The Controller of Capital Issues must give permission to the issue.

What are the benefits of issue of bonus shares?

  • The investor is not required to pay any tax upon receiving the bonus shares.
  • It is specifically beneficial for the investors who believe in the long-term story of the company and want to increase their investment in the same.
  • Issuing additional shares and using cash for the business growth of the company increases the investor’s belief in operations of the company.
  • If the company starts paying the cash dividend in the future, the investor receives more because he holds a number of shares in the company due to past policy of paying a stock dividend.
  • Bonus shares give positive sign to the market that the company is committed towards long term growth story.
  • Bonus shares increase the outstanding shares which in turn enhances the liquidity of the stock.
  • The perception of the company’s size increases with the increase in the issued share capital.

Issue of Right Shares

A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. This type of issue gives existing shareholders securities called rights. With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.

Provisions of Right Issues as per the Companies Act

Issue of Share on Rights basis is covered under Section 62 of the Companies Act, 2013. According to Section 62(1)(a), further shares shall be offered to persons who, at the date of the offer, are holders of equity shares of the company in proportion, as nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer subject to the following conditions, namely:

  • the offer shall be made by notice specifying the number of shares offered and limiting a time not being less than 15 days and not exceeding 30 days from the date of the offer within which the offer, if not accepted, shall be deemed to have been declined
  • unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercisable by the person concerned to renounce the shares offered to him or any of them in favour of any other person; and the notice shall contain a statement of this right
  • after the expiry of the time specified in the notice, or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept the shares offered, the Board of Directors may dispose of them in such manner which is not dis-advantageous to the shareholders and the company

Differences between Bonus Issue and Rights Issue

  • Rights shares are offered to the existing shareholders by the company for raising additional capital from the market. This has to be done within a stipulated time period. On the other hand, bonus shares are given to the shareholders out of the free reserves created from additional profits made by the company during the year.
  • The objective of the rights issue is to insert additional capital in the company as compared to bonus shares which aim to increase active trading through an increase in a number of outstanding shares.
  • Rights shares are offered at a discounted price compared to the market price. Bonus shares are issued to the shareholders free of cost.
  • Rights shares are either partly paid or fully paid-up depending on the proportion of the paid-up value of equity shares when the further issue takes place. On the other hand, bonus shares are always fully paid up.
  • Rights issue permits the renunciation of rights which have been issued either partially or completely, though no such option is available for bonus shares.
  • The base of shareholders can increase in a rights issue if they are not accepted by the existing shareholders and somebody else accepts it. However, bonus shares are only given to the existing list of shareholders.

Both Right Shares and Bonus Shares are methods to increase the number of shares in the market thereby enhancing shareholder value. Though rights issues come at a less cost, bonus shares are given free of cost. Thus, depending on the decisions of the senior management and position of the company in the industry, the respective strategy is pursued.

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