Learn About Section 63 of Companies Act, 2013

Section 63 of the Companies Act, 2013, allows companies to reward their shareholders by issuing bonus shares without any extra cost. These shares are distributed from the company's accumulated profits or reserves, such as free reserves, securities premium account, or capital redemption reserve account. However, reserves created by revaluing assets cannot be used for this purpose. Let us explore the concept of Section 63 of Companies Act, 2013 in this article.

What is Section 63 of Companies Act, 2013?

Section 63 of the Companies Act, 2013, states that companies are allowed to give bonus shares, or additional fully paid-up shares, to current owners at no additional expense. These shares are distributed from the company's free reserves, securities premium account, or capital redemption reserve account. However, reserves created by revaluing assets cannot be used for this purpose. To issue bonus shares, a company must be authorized by its Articles of Association, obtain approval from shareholders in a general meeting, and ensure there are no defaults in payments to creditors or employees. Importantly, bonus shares cannot replace dividends. ?

What are Bonus Shares?

Bonus shares are additional shares that a company gives to its existing shareholders at no extra cost. These shares are issued in proportion to the number of shares already owned. In order to reward shareholders and turn their reserves into share capital, companies issue bonus shares. This increases the total number of shares without affecting the overall value of the company and keeps each shareholder’s ownership percentage the same. Bonus shares are a common substitute for cash dividends.

What are the Sources for Bonus Shares?

?When a company decides to issue bonus shares, additional shares given to existing shareholders without any extra cost, it must utilize specific financial reserves as outlined in Section 63 of the Companies Act, 2013. These reserves represent the company's accumulated profits and are used to reward shareholders without affecting the company's cash flow. ?

Section 63 (1)

Section 63(1) of the Companies Act, 2013, deals with the issuance of bonus shares by a company. It outlines the conditions and sources from which fully paid-up bonus shares can be issued to members. These bonus shares are essentially free shares given to existing shareholders, typically funded from the company's profits or reserves.

Here's a more detailed breakdown:

1. Issuance of Bonus Shares:

Section 63(1) allows companies to issue fully paid-up bonus shares to their members.

2. Funding Sources:

These bonus shares can be funded from the company's free reserves, securities premium account, or capital redemption reserve account. They cannot be issued by capitalizing reserves created from the revaluation of assets.

3. No Capitalization of Reserves:

The company cannot issue bonus shares by capitalizing reserves unless it is authorized by its articles of association, recommended by the board and authorized in the general meeting, and it has not defaulted on payments to debt holders or statutory dues like provident fund, gratuity, or bonus.

4. Not in Lieu of Dividend:

Bonus shares cannot be issued in place of a dividend payment.

Section 63 (2)

Section 63(2) of the Companies Act, 2013 outlines the conditions that must be met before a company can capitalize its profits or reserves to issue bonus shares. Essentially, a company can only issue bonus shares if it has the proper authorization, has not defaulted on payments, and complies with certain prescribed conditions. 

Elaboration:

1. Authorization:

• The company's articles of association must authorize the issue of bonus shares.
• A general meeting of the company, on the recommendation of the board, must also authorize the issuance.

2. Financial Obligations:

• The company must not be in arrears on fixed deposits or debt securities.
• It must not be in default of statutory dues like provident fund, gratuity, or bonus for employees.

3. Share Capital:

• Any partly paid-up shares must be made fully paid-up before issuing bonus shares.

• Compliance with Regulations:

• The company must comply with any other conditions or regulations prescribed by the relevant authorities.

5. No Dividend Substitution:

• The bonus shares cannot be issued in place of a dividend.
• In essence, Section 63(2) ensures that bonus share issues are carried out responsibly and do not jeopardize the financial stability or obligations of the company.

Section 63 (3)

Section 63(3) of the Companies Act, 2013 prohibits a company from issuing bonus shares in lieu of a dividend. This means that bonus shares cannot be distributed as a replacement for a cash dividend payment to shareholders.

Key points:

• Bonus shares:

Fully paid-up shares issued by a company to its existing shareholders, typically using reserves or profits, without any cash outlay from the company.

• In lieu of dividend:

As a substitute for a cash dividend that would otherwise be paid out to shareholders.

• Prohibition:

Section 63(3) specifically prevents bonus shares from being used as a substitute for a cash dividend.

Purpose:

The intention behind bonus shares is often to reward shareholders for their investment without immediately reducing the company's cash reserves.

Primary Sources for Bonus Shares

• Free Reserves: These are the profits that a company has retained over time after paying dividends and meeting other obligations. They are available for distribution and can be converted into share capital for issuing bonus shares. ?
• Securities Premium Account: This account holds the amount received by the company over and above the face value of its shares during issuance. According to the Companies Act, the funds kept in this account may be utilized for certain things, such as granting bonus shares.
• Capital Redemption Reserve Account: Created when a company redeems its preference shares, this reserve ensures that the company's capital remains intact. It can be used to give stockholders bonus shares that have been completely paid. 

What Are the Conditions to Issue Bonus Shares?

Issuing bonus shares involves several important considerations to ensure fairness and compliance with legal standards. Under Section 63 of the Companies Act, 2013, companies must meet specific conditions before distributing bonus shares to their existing shareholders, which are mentioned below:

• Shareholder Approval: A recommendation from the board of directors must be approved by shareholders in a general meeting.
• Authorization in Governing Documents: Bonus shares must be issued following the company's Articles of Association. If not, they ought to be changed appropriately.
• Financial Compliance: The Company should not have defaulted on payments related to fixed deposits, debt securities, or statutory dues such as employee provident fund contributions.
• Fully Paid-Up Shares: Any partly paid shares must be fully paid before issuing bonus shares.
• Timely Implementation: Once it is announced, the bonus issue should be executed promptly, usually within 15 days if shareholder approval isn’t required or within two months if it is needed.         

Procedure for the Issue of Bonus Shares

Issuing bonus shares is a formal process that a company must follow carefully, as per the Companies Act, 2013. Here is the procedure for the issue of bonus shares:

Step 1: Call a Board Meeting

The first step is to schedule a Board Meeting. Section 173(3) of the Companies Act mandates that all directors must get notice of the upcoming board meeting at least seven days in advance. They have plenty of time to get ready for the meeting thanks to this.

Step 2: Hold the Board Meeting

Once the meeting is scheduled, the Board of Directors must gather to discuss and approve the proposal to issue bonus shares. During this meeting, the following things must be done:

1. Check the Quorum: At least one-third of the total number of directors must be present for the meeting to be valid.
2. Approve the Bonus Issue: A Board Resolution should be passed to approve the bonus issue. This decision will then be placed before the shareholders for final approval at a general meeting.
3. Decide the Bonus Ratio: The Board must decide how many bonus shares will be given for every existing share.
4. Schedule the General Meeting: Fix the date, time, and place for the General Meeting where shareholders will vote on the proposal

Appoint a director to send out the meeting notices to all necessary parties

Step 3: Share the Draft Minutes of the Board Meeting

After the board meeting, the draft minutes, which are a summary of decisions taken, must be shared with all directors for their comments. Also, within 30 days after the meeting, the board resolution that was approved by the public company must be submitted to the Registrar of Companies (RoC) using Form MGT-14.

Step 4: Send Notice of General Meeting

A formal notice for the General Meeting must be sent to all shareholders, the company auditors, directors, and any other eligible members. This notice must be sent at least 21 clear days before the date of the meeting. This equals 21 days, which does not include the day of the meeting or the notice's mailing.

Step 5: Hold the General Meeting

The company must now hold the Extraordinary General Meeting (EGM). At this meeting, the shareholders must pass an Ordinary Resolution, which is a simple majority vote, to approve the bonus issue. The power to distribute the bonus shares must be granted to the Board.

Step 6: Hold another Board Meeting for Allotment

After receiving shareholder approval, the company must hold another board meeting to officially approve the allotment of bonus shares to eligible shareholders. Complete the formalities related to the allotment.

Step 7: File Return of Allotment (Form PAS-3)

After the bonus shares are distributed, the company has 30 days to submit Form PAS-3 to the RoC. The form must include a copy of the Ordinary Resolution passed in the General Meeting, a copy of the Board Resolution approving the allotment, a certified list of allottees with their name, address, occupation, and the number of bonus shares received. And any other supporting documents, if needed.

Step 8: Issue of Share Certificates or Credit to Demat Account

Finally, after the allotment, if the shares are in Demat form, the company must immediately inform the depository, like NSDL or CDSL. The company has two months from the date of allocation to issue the share certificates if the shares are held in tangible form.

Tax Aspects of Bonus Shares

Receiving bonus shares isn't taxable, but selling them can have tax implications under the Indian Income Tax Act, 1961. ?The tax Implications of bonus shares are mentioned as follows:

No Tax at the Time of Receipt           

When you receive bonus shares, there is no tax liability at that moment. These shares are issued free of cost, so they don't attract any immediate tax. ?

Taxation upon Sale

When you sell the bonus shares, you are liable for taxes. The holding duration determines whether the capital gain is short-term or long-term:

• Short-Term Capital Gains (STCG): If you sell the bonus shares within 12 months of allotment, the profit is considered short-term capital gain. As per the 2024 budget, STCG is taxed at 20%. ?
• Long-Term Capital Gains (LTCG): If you sell the bonus shares after holding them for more than 12 months, the profit is considered long-term capital gain. LTCG exceeding Rs. 1 lakh is taxed at 12.5%. ?

Cost of Acquisition

For tax purposes, the cost of acquisition of bonus shares is considered zero. Therefore, the entire sale proceeds are treated as capital gains. ?

Holding Period Consideration

The holding period for bonus shares starts from the date of allotment. It is essential to track this date to determine whether the gain is short-term or long-term. ?

Reporting on Tax Returns

When filing your income tax return, you must report the sale of bonus shares under the 'Capital Gains' section, providing details like the date of allotment, date of sale, and sale consideration. ?

Strategic Planning

Investors often plan the sale of bonus shares to optimize tax liability. For instance, holding bonus shares for more than a year can reduce the tax rate applicable to gains.

Advantages of Bonus Shares

The advantages of bonus shares for both the company and its shareholders are mentioned below:

Advantages for a Company

• Enhances Market Perception: Issuing bonus shares signals the company's strong financial health and commitment to rewarding shareholders, which improves its reputation in the market. ?
• Conserves Cash Reserves: By distributing bonus shares instead of cash dividends, the company retains cash for operational needs or future investments. ?
• Increases Share Liquidity: An increase in the number of shares outstanding can lead to higher trading volumes, which makes the stock more liquid and potentially more attractive to investors. ?
• Attracts Retail Investors: Lower share prices post-bonus issue can make the stock more affordable, which encourages participation from small investors.

Advantages for a Shareholder

• Cost-Free Additional Shares: Shareholders receive extra shares without any additional investment, effectively increasing their total shareholding. ?
• Tax Efficiency: Receiving bonus shares is not considered a taxable event in India; taxes are applicable only when these shares are sold, potentially offering tax planning benefits. ?
• Improved Liquidity: With more shares in the market, shareholders may find it easier to buy or sell shares without significantly impacting the stock price. ?
• Signals Company Confidence: A bonus issue often reflects the company's confidence in its future earnings, reinforcing shareholder trust and satisfaction.

Compliance and Regulatory Considerations

Issuing bonus shares is a significant corporate action that requires listed companies to adhere to specific compliance and regulatory guidelines set by the Securities and Exchange Board of India (SEBI). They are mentioned as follows:

Compliance with SEBI Regulations

Listed companies must follow SEBI’s regulations, particularly the SEBI (issue of capital and disclosure requirements) regulations, 2018, which include the following:

• Eligibility: Bonus shares can be distributed from capital redemption reserves, securities premium accounts, or free reserves. This cannot be done with revaluation reserves.
• Authorization: Bonus shares should be issued following the company's articles of association. If not, they must be amended accordingly.
• Approval: A board resolution recommending the bonus issue must be passed, followed by shareholders’ approval in a general meeting.
• No defaults: The company should not have defaulted in payment of interest or principal on fixed deposits or debt securities.
• Fully Paid-Up Shares: Bonus shares cannot be issued until all current partially paid-up shares have been paid in full.

Timely Filings and Closures

Adhering to timelines ensures transparency and investor confidence:

• Board Meeting Outcome: The decision to issue bonus shares must be disclosed to stock exchanges within 30 minutes of the board meeting’s conclusion.
• Record Date: The company must announce the record date for determining eligible shareholders at least seven working days in advance.
• Filing with SEBI: Necessary filings, such as the return of allotment, should be submitted within 30 days of allotment.

Transparency with Stakeholders                 

Maintaining open communication fosters trust:

• Clear Communication: Inform shareholders about the bonus issue details which includes the ratio, record date, and rationale.
• Consistent Updates: Provide timely updates on the progress of the bonus issue process.
• Investor Queries: Address any questions or concerns from investors promptly and transparently.

Common Mistakes to Avoid

Issuing bonus shares is a very important corporate action that requires adherence to legal and regulatory frameworks. Missteps in this process can lead to severe consequences, which include penalties and reputational damage. Here are the common mistakes to avoid when issuing bonus shares:

1. Issuing Bonus Shares Without Proper Authorization

Before initiating a bonus issue, it is imperative to ensure that the company’s articles of association (AoA) permit such an action. If the AoA lacks this provision, it must be amended accordingly. The bonus issue should be authorized by the shareholders in a general meeting based on the board’s recommendation. Neglecting these steps can render the bonus issue invalid and may attract legal challenges.

2. Non-Compliance with Statutory Requirements

There may be severe penalties for breaking statutory obligations. SEBI mandates that listed companies complete the bonus issue process within 15 days from the date of board approval. Delays can attract fines of Rs. 20,000 per day until the compliance is achieved. If the non-compliance extends beyond 15 days, an additional fine of 0.01% of the company’s paid-up capital or Rs. 1 crore, whichever is less, may be imposed.

3. Ignoring the Impact on Authorized Share Capital

A bonus issue increases the number of outstanding shares, which must be within the limits of the company’s authorized capital is insufficient, the company must pass a resolution to increase it before issuing bonus shares. Overlooking this requirement can lead to the issuance of shares beyond the authorized limit, which results in legal complications and potential penalties.

Section 63 of Companies Act, 2013 offers companies a practical way to record shareholders by issuing bonus shares without any extra cost. It helps improve investor trust, enhances liquidity, and strengthens a company’s market image, all without affecting its cash reserves. This process must be carried out responsibly, following SEBI regulations, meeting filing deadlines, and maintaining clear communication with stakeholders. By avoiding common mistakes and staying legally compliant, companies can turn bonus shares into a strategic advantage for both themselves and their shareholders. Contact Online Legal India to get assistance and learning more about section 63 of Companies Act, 2013.