The bonus issue of shares is a great mechanism in the corporate world that benefits both companies and shareholders. It is an alternative to cash dividend payments, where investors get more shares in proportion to their existing holdings without further investment. But what is a bonus issue, and how does it affect investors? This blog will explain the concept of bonus shares, their advantages, and common FAQs.
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A bonus issue of shares, also known as a scrip issue or capitalisation issue, is when a company distributes additional shares to its existing shareholders free of charge. These new shares are issued in a ratio to the shareholders’ existing holdings, such as “two bonus shares for every five held.”
Unlike cash dividends, bonus shares are issued from the company’s undistributed reserves or retained earnings. Instead of paying out profits in cash, the company reinvests them back into equity, thus increasing the number of outstanding shares without changing the company’s market capitalization.
Companies issue bonus shares for various reasons:
A bonus issue allows companies to reward their current shareholders by increasing their shareholding without them having to put in more money. This is often seen as a goodwill gesture to retain loyalty.
By increasing the number of shares in the market, bonus issues can increase trading activity. With more shares out there, share prices may become more affordable for retail investors and this improves liquidity.
Instead of distributing profits as cash dividends, companies can use accumulated profits to issue bonus shares, which keeps cash for future use.
A bonus issue can create a good image of the company and shows confidence in future profitability. It means the company has sufficient profits or reserves to justify such an issue.
Issuing bonus shares shows a company is in good financial health. This boosts investor confidence.
For UK investors, bonus shares are generally not taxed as income. They are only taxed for capital gains tax (CGT) purposes when sold. That is a deferred tax advantage.
Although the share price may drop post-issue due to the increased number of shares, the overall value of an investor’s holdings remains the same. Over time, the company’s growth can enhance the value of these extra shares.
Lower share prices after a bonus issue makes the stock more attractive to retail investors, and increases demand and liquidity.
A bonus issue shows the company can use its retained earnings, which means the company’s balance sheet is strong.
After a bonus issue, the share price usually goes down in proportion to the number of shares issued. For example, if a stock trades at £100 and a 1:1 bonus issue is announced, the share price may adjust to £50 after the issue.
Shareholders get more shares, though the total value of their investment doesn’t change initially.
Future dividend payments may be diluted as the total number of shares increases, and the company’s profits are spread over a larger base.
How Are Bonus Shares Taxed in the UK?
In the UK, bonus shares are not taxed when issued. But they are counted for capital gains tax (CGT) purposes when sold. The acquisition cost for CGT purposes is adjusted based on the original purchase price of the shares and the bonus issue ratio.
Is a Bonus Issue Good for Investors?
Yes, a bonus issue of shares can be beneficial for investors. It increases their shareholding without requiring them to invest more. But the immediate financial gain is limited, as the share price adjusts accordingly.
Can I Sell Bonus Shares Immediately?
Yes, you can sell bonus shares as soon as they are credited to your account. But think of market conditions and tax implications first.
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