SEBI Regulations for Issuing Bonus Shares

Every year, dozens of listed Indian companies reward loyal shareholders with bonus shares instead of, or alongside, cash dividends. It sounds simple: more shares, same ownership, no extra payment. But behind every bonus issue sits a strict rulebook designed to stop companies from manufacturing paper wealth out of thin air. That rulebook comes largely from the Securities and Exchange Board of India, and understanding it is essential for any commerce student studying corporate accounting and share capital.

What makes bonus shares different from an ordinary share issue 🔗

A bonus share is a fully paid-up share given free of cost to existing shareholders, in proportion to their current holding. No fresh money comes into the company. Instead, the company converts a part of its accumulated profits or reserves into share capital, a process called capitalisation of reserves. The shareholder’s stake in the company does not change; what changes is the number of shares representing that stake, along with the face value math.

Because no cash changes hands, it might seem like a purely internal accounting adjustment. In practice, bonus issues affect market price, investor perception, and the balance sheet’s structure, which is exactly why SEBI regulates the process through its Issue of Capital and Disclosure Requirements (ICDR) Regulations, 2018, alongside the provisions of the Companies Act, 2013.

Why SEBI guidelines exist at all 🔗

Without regulation, a company could inflate its share count using reserves that were never genuinely earned, or issue shares to certain classes of investors while ignoring others who hold convertible instruments. SEBI’s role is to make sure a bonus issue reflects real, distributable profit and treats every category of security holder fairly. This connects directly to the broader unit theme of shareholder protection that also governs the redemption of preference shares: both processes exist to keep a company’s capital structure honest and creditors’ interests intact.

The source of funds must be genuine 🔗

The single most important condition is where the money for bonus shares comes from. According to SEBI’s guidelines, a bonus issue must be made out of free reserves built from genuine profits, or out of the securities premium account, provided that premium was collected in cash. Reserves created by revaluing fixed assets cannot be capitalised this way, because a revaluation reserve represents an estimated increase in asset value on paper, not real, realised profit.

The Companies Act, 2013 reinforces this at the statutory level. Section 63 permits a company to issue fully paid-up bonus shares out of free reserves, the securities premium account, or the capital redemption reserve account, while explicitly barring the use of revaluation reserves for this purpose.

Why “cash-collected” premium matters 🔗

Not all securities premium qualifies. If a company received premium in a form other than cash, for instance through an asset swap, that portion cannot be used to fund a bonus issue. This distinction prevents companies from using non-cash accounting entries to justify handing out free shares.

Protecting holders of convertible debentures 🔗

Companies sometimes have Fully Convertible Debentures (FCDs) or Partly Convertible Debentures (PCDs) outstanding, holders of which will become shareholders only after conversion. SEBI’s guideline addresses what happens if a bonus issue is announced before that conversion takes place. A company cannot issue bonus shares while conversion of FCDs or PCDs is pending unless it extends a similar benefit to those debenture holders, typically by reserving shares in proportion to the convertible portion of their holding. Those reserved shares are then issued at the time of conversion, on the same terms as the original bonus issue.

This rule exists so that a shareholder who happens to hold shares today does not gain an unfair advantage purely because of timing, at the expense of an investor who will become a shareholder only a few months later.

No history of default 🔗

A company cannot reward shareholders with bonus shares while it owes money elsewhere. The guidelines require that the company has not defaulted in payment of interest or principal on fixed deposits or debt securities, and has not defaulted on statutory dues owed to employees, such as provident fund contributions, gratuity, or bonus payments. If a company were allowed to distribute bonus shares while defaulting on debenture interest, it would effectively be prioritising shareholders’ symbolic reward over creditors’ and employees’ legitimate claims. SEBI’s default check keeps that priority in order.

Partly paid shares must be cleared first 🔗

If a company has any partly paid-up shares outstanding, it must convert them into fully paid-up shares before it can issue bonus shares. Allowing a bonus issue while some existing shares remain partly paid would create an uneven capital structure and could unfairly benefit shareholders who have not yet paid their full call money, compared to those who have already contributed in full.

The Articles of Association must permit it 🔗

A company’s Articles of Association need to contain a specific provision allowing capitalisation of reserves for a bonus issue. If no such clause exists, the company must first pass a resolution at its general meeting to insert one. Only after this authorisation, along with a board recommendation and shareholder approval at a general meeting, can a company proceed. Additionally, if the resulting increase in paid-up capital exceeds the company’s authorised share capital, another resolution is needed to raise the authorised capital limit.

Bonus shares cannot substitute for a dividend 🔗

SEBI is explicit that a bonus issue cannot be declared in lieu of dividend. Shareholders are entitled to receive dividends as a distribution of profit; bonus shares are a separate, additional benefit tied to capital restructuring. A company cannot dodge its dividend obligations by offering bonus shares instead and calling it equivalent value.

Strict timelines once approved 🔗

Once a bonus issue is approved, SEBI does not allow companies to sit on the decision indefinitely. Under Regulation 295 of the SEBI (ICDR) Regulations, 2018, if shareholder approval is not required for the capitalisation of profits, the issuer must complete the bonus issue within fifteen days of board approval. Where shareholder approval is required, the company must complete the process within two months of the board meeting date, as legal analysts have noted, with daily fines applying for delays. A company also cannot withdraw a bonus issue once its board has announced the decision.

A quick reference table 🔗

How this connects to redemption of preference shares 🔗

Students studying this topic alongside redemption of preference shares will notice a common thread: both processes involve using company reserves to alter the capital structure without an inflow of fresh cash, and both are hedged around with conditions to protect creditors and ensure reserves used are genuinely distributable. Just as preference shares can only be redeemed out of profits otherwise available for dividend or out of a fresh issue of shares, bonus shares can only be funded from reserves that represent real, realised profit. The underlying accounting logic, protecting the company’s capital base while rewarding stakeholders, runs through both topics.

What these guidelines actually protect 🔗

Taken together, the SEBI framework serves three goals. It ensures that a bonus issue reflects genuine financial strength rather than accounting manipulation. It ensures fairness across different classes of security holders, including those who will become shareholders later through conversion. And it maintains market integrity by preventing companies from using bonus announcements as a way to artificially move share prices without any real change in underlying value. For a market where retail participation has grown sharply in recent years, these safeguards matter more than ever.

What do you think? If a company has strong free reserves but has defaulted on debenture interest payments, should shareholders still expect a bonus issue anytime soon? And why might regulators treat a revaluation reserve so differently from a cash-backed securities premium, even though both appear as reserves on the balance sheet?

References

1. https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-issue-of-capital-and-disclosure-requirements-regulations-2018-last-amended-on-july-25-2022-_61425.html
2. https://www.sebi.gov.in/guide/guide200015.html
3. https://taxguru.in/company-law/bonus-shares-issue-companies-act-2013.html
4. https://agrudpartners.com/sebi-icdr-regulations-2018-legal-framework/