Bonus shares explained: what they are, why companies issue them, and the real impact on investors

How a bonus issue works: the mechanics

A company announces a bonus issue in a specific ratio: for example, a 1:1 bonus means one additional share is issued for every one share held, doubling the shareholder's share count. A 2:1 bonus means two additional shares for every one held, tripling the count. On the record date, the company's registrar takes a snapshot of all shareholders and issues new shares to those on the register. The shares are credited to demat accounts within a few days of the record date.

The accounting entry for a bonus issue transfers reserves from accumulated profits (retained earnings) or securities premium into paid-up equity share capital. No cash leaves the company - the bonus issue is purely a balance sheet reclassification. The share price adjusts on the ex-bonus date (the day after the record date): if a stock was trading at 1000 rupees and a 1:1 bonus is issued, the adjusted ex-bonus price is 500 rupees. Each shareholder now holds twice as many shares at half the price, for an identical total value. The bonus does not create wealth - it repackages existing ownership into more units.

Why companies issue bonus shares

Companies issue bonus shares for several operational and strategic reasons. First, a high absolute share price reduces retail participation because fewer investors can afford to buy round lots; a bonus issue at 1:1 or 2:1 halves or reduces the price, improving affordability and liquidity. A more liquid, actively traded stock typically commands a valuation premium. Second, a bonus issue signals management confidence: by converting free reserves into equity, the board is saying that these reserves are permanent and available to be capitalised, rather than returned as a special dividend. Third, for promoters who do not want a taxable cash event (dividends are taxed in the hands of recipients above a threshold), a bonus issue allows them to maintain their proportional stake without a tax outflow.

A bonus issue also formally locks up reserves: once transferred to paid-up capital, these reserves cannot easily be paid out as dividends in the future. This is an important governance signal - it reduces the flexibility to return capital and increases the permanent equity base of the company, which affects future ratios like EPS and book value per share.

Tax treatment and practical investor implications

In India, bonus shares received by shareholders are not taxed at the time of receipt - no tax liability arises when the shares are credited to your demat account. However, the cost of acquisition for the bonus shares is taken as zero for capital gains tax purposes. When you eventually sell the bonus shares, the entire sale proceeds (minus brokerage and transaction costs) are treated as capital gain, with the holding period calculated from the date of allotment of the bonus shares.

Original shares held before the bonus issue retain their original purchase price and holding period for capital gains calculation. Bonus shares are treated as a separate lot with zero cost and a new acquisition date. If you sell bonus shares before one year of allotment, short-term capital gains tax at 20 percent applies. If held beyond one year, long-term capital gains tax at 12.5 percent applies on gains above the 1.25 lakh annual exemption threshold. Record this separately in your portfolio tracker because the zero-cost basis means the tax impact on eventual sale is higher than on your originally purchased shares.

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Common questions on what is a bonus share.

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