Bonus Shares

31st August, 2024 Economy

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Context

In its 47th annual general meeting (AGM), Reliance Industries announced a bonus issue for the company’s shareholders in a 1:1 criterione. one bonus share each for one share held by its shareholders.

Bonus shares are extra shares given to current shareholders for free. Companies issue them to reward shareholders and use up their reserves.
For example, a 1:1 bonus issue means shareholders get one new share for each share they already own.

When a company announces a bonus issue, it sets the ratio and the record date, which is the date by which shareholders must own shares to get the bonus. For instance, if someone has 100 shares and the company offers a 1:1 bonus, they will receive 100 additional shares, making their total 200 shares.

Bonus shares are not taxed upon receipt. However, when they are sold, any profit made is subject to capital gains tax. Since the acquisition cost of bonus shares is considered zero, the entire sale amount will be treated as capital gain.

Companies issue bonus shares to make their stock more affordable for small investors if the share price has risen too high.
This increases the number of shares and lowers the price per share, making the stock more attractive. Bonus shares also reward loyal shareholders and show confidence in the company's future.

While bonus shares increase the number of shares, they do not change the company's market capitalisation.
Market capitalisation remains the same because it is the total market value of all outstanding shares, calculated by multiplying the share price by the total number of shares.
After a bonus issue, the share price usually drops to reflect the higher number of shares, keeping the market capitalisation unchanged.

PRACTICE QUESTION

Q. Consider the following statements:

Bonus shares are extra shares given to current shareholders for free.
A 1:1 bonus issue means shareholders receive one new share for each share they already own.
Bonus shares are taxed upon receipt.

Which of the above statements is/are correct regarding bonus shares?

A) 1 and 2 only
B) 1 and 3 only
C) 2 and 3 only
D) 1, 2, and 3

Answer: A) 1 and 2 only

Explanation:

Statement 1 is correct: Bonus shares are extra shares given to current shareholders for free. Bonus shares are issued by a company to its existing shareholders at no additional cost, typically as a way to distribute accumulated profits.
Statement 2 is correct: A 1:1 bonus issue means shareholders receive one new share for each share they already own. In a 1:1 bonus issue, shareholders receive one additional share for every share they currently own.
Statement 3 is incorrect: Bonus shares are not taxed at the time of receipt. However, they may affect the cost basis of the shares for capital gains tax purposes when they are eventually sold.

SOURCE: HINDUBUSINESSLINE