Bonus Issue

Bonus Issue of Shares

A bonus issue (also called a scrip or capitalization issue) is when a company issues additional shares to existing shareholders for free, in proportion to their current holdings. It increases the number of outstanding shares without changing each shareholder’s percentage ownership.

Key takeaways

• Bonus shares raise a company’s share capital but do not change its market capitalization; the share price adjusts proportionally.
• They are funded by converting retained earnings or reserves into share capital (no cash payment to shareholders).
• Bonus issues do not dilute percentage ownership, but they reduce per‑share metrics (earnings per share, dividends per share).
• Issuance is not taxed when received; capital gains tax applies if the shares are later sold for a profit.

How a bonus issue works

When a company declares a bonus issue, it specifies a ratio (for example, 1:5, 1:1, or 3:1). Each shareholder receives that number of bonus shares for each share they already own.

Example:
* A three‑for‑one bonus issue means a shareholder with 1,000 shares receives 3,000 additional shares (now holding 4,000 total).
* In a one‑for‑one bonus, a shareholder with 100 shares receives 100 additional shares; if the share price was $10 before the issue, it typically adjusts to about $5 after the issue so the total holding value remains essentially the same.

The company funds the bonus by capitalizing reserves (moving amounts from retained earnings or share premium to share capital). This increases the share capital on the balance sheet but does not generate cash for shareholders.

Why companies issue bonus shares

Companies typically issue bonus shares for one or more of these reasons:
* Make shares more affordable and boost retail investor participation by increasing outstanding shares and lowering the per‑share price.
* Provide an alternative to cash dividends when the firm prefers to reward shareholders without distributing cash.
* Signal financial strength by demonstrating sufficient reserves and retained earnings.

Advantages

• Increased liquidity and lower per‑share price can attract smaller investors.
• Acts as a non‑cash method to reward shareholders when dividends are impractical.
• May signal confidence in the company’s financial position.
• No immediate tax at issuance; tax consequences arise only on later sale.

Disadvantages

• Opportunity cost: funds transferred to share capital could otherwise be used for investments, acquisitions, or returning cash to shareholders.
• Potential reduction in future cash dividends since the company is not distributing cash.
• No immediate monetary gain for shareholders — total value remains roughly the same after adjustment, while per‑share metrics decline.

Stock splits vs. bonus shares

• Stock split: existing shares are divided into a larger number of shares (e.g., 2‑for‑1). It increases the share count and lowers the per‑share price but does not change the company’s share capital or reserves.
• Bonus issue: additional shares are issued by capitalizing reserves into share capital. It also increases outstanding shares and lowers the per‑share price, but the accounting treatment differs because reserves are reclassified rather than altering the nominal face value per share.

Both aim to improve liquidity and make shares more accessible; the key distinction is that a bonus issue involves a transfer within shareholders’ equity (reserves → share capital), whereas a split is purely a change in share count and par value.

Taxation

Bonus shares are not taxable when issued. Taxable events generally occur when the shares are sold: capital gains tax applies on the net gain from the sale. Investors should maintain records of bonus shares received and consult tax advisors for cost‑basis and holding‑period implications.

Bottom line

A bonus issue is a way to reward shareholders and increase liquidity without changing ownership percentages or market capitalization. It converts reserves into additional shares, lowering the per‑share price and per‑share financial metrics. Companies use bonus issues to attract investors, preserve cash, and signal financial health, but doing so carries opportunity costs and may affect future dividends.