A routine bonus issue triggered much debate and even criticism recently. If you remember, e-commerce brand Nykaa announced a bonus share issue with an ex-date of November 10, 2022 — coincidentally or otherwise that date matched with the end of the lock-in period for the pre-IPO investors. This has been quite criticised by some analysts and other stakeholders. But a bonus issue by itself isn’t contentious. Here’s what you must know about bonus issues and their impact on share prices.

What is it?

Bonus issue of shares is a corporate action where the company gives out additional shares to the existing shareholders. The additional shares are paid for from the reserves of the company. Usually, these reserves lie idle. without much use to the balance sheet. These additional shares are given to shareholders proportionate to their existing holding. So, a 2:1 issue means two shares for every one share held.

Why

The bonus issue may be construed as a balance sheet adjustment where the unutilised reserves of the company are converted into new equity shares and given to the existing shareholders. Since a bonus issue does not involve any cash consideration, the share capital of the company does not increase its net assets.

A company may issue bonus shares if it feels that there isn’t enough liquidity for its scrip in the markets, or if the price in absolute terms is too large, leading to limited participation from investors. When the bonus issue concludes, and new shares are issued to shareholders, the share price corrects and adjusts according to the number of shares outstanding.

Timelines

A company announces a record date and shareholders on record that day will be given the bonus shares; one or two days prior to record date is the ex-date. Since share settlement in India happens on a T+2 days basis, new investors who wish to invest in the shares to get bonus shares must buy the shares at least one day before the ex-date. For instance, the recent bonus issue of Nykaa had November 11, 2022, as its record date and the ex-date was November 10, 2022, which means that anyone who bought the shares on November 9, 2022, will also be eligible for bonus shares.

Stock reaction

There is an increase in the number of shares outstanding, but there is no fundamental change in the company. The overall value of the company remains unchanged. Therefore, the price of the stock falls to match the original price. For instance, Nykaa announced bonus issue of 5:1 and the share price dropped from ₹ 1060.3 to ₹167 on November 10, 2022. But lower absolute prices can sometimes trigger more buying and stock price rallies.

Tax implications

Taxation of the sale of shares with bonus issue is not straight forward.  The calculation of tax has to be done separately for bonus shares and acquired shares. It is calculated separately because the cost of acquisition for the bonus shares is nil. Consider this: Amar holds 100 shares of Nykaa which he bought at ₹2,245 each on November 12, 2021. In November 2022, Nykaa announced A bonus issue in the ratio 5:1. Therefore, Amar got another 500 shares of Nykaa. Amar now decides to sell his complete holding of 600 shares on November 25, 2022 for, say, ₹176. In this case the loss on original 100 shares bought at ₹ 2245 each will be ₹ 2,06,900 (₹ 17,600 is sale price - ₹ 2,24,500 is cost of acquisition) and considered as long-term capital loss as the holding period is more than 1 year. The sale of bonus shares will result in a gain of ₹ 88,000 (500*₹176) because the cost of acquisition of bonus shares is zero. Since the bonus shares are held for a period less than 1 year it will be considered as short-term capital gain and taxed at 15 per cent which will result in a tax liability of ₹ 13,200 (₹ 88000 * 15 per cent). The long-term capital loss can be adjusted only against long term capital gain only. This was the main criticism faced by Nykaa for its bonus issue as the investors will have to pay tax despite losing money.

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