Issue of Shares Under Companies Act 2013 – Types

Issue of shares under the Companies Act, 2013 refers to the process by which a company raises capital by allotting shares to existing shareholders, investors, employees, promoters or other eligible persons in accordance with the provisions of the Act. The Act governs various modes of share issuance, including rights issue, preferential allotment, bonus shares, private placement and sweat equity shares, while prescribing conditions relating to approvals, disclosures, valuation, allotment and compliance to ensure transparency and protection of shareholders’ interests.

Table of Contents

Rights Issue
‘Preferential Allotment’ in Case of Fresh Issue of Securities
Bonus Shares
Sweat Equity Shares

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1. Rights Issue

Further shares to members as their right.

As per section 62(1) of Companies Act, 2013 [Corresponding to section 81(1)(a) of the 1956 Act] if the company decides to issue fresh shares, these should be offered to existing shareholders in proportion (as nearly as practicable) to existing persons who are holders of equity shares.

This is termed as ‘rights issue’.

‘Rights Issue’ means offering shares to existing members in proportion to their existing shareholding. The object is, of course, to ensure equitable distribution of shares and the proportion of voting rights is not affected by issue of fresh shares.

Only One Pre-emptive Right is to Be Given – It is now well settled that only one pre-emptive offer is to be made which is otherwise (should be ‘either’) to be accepted or not at all. The existing shareholders are not to be given further pre-emptive rights in respect of those unaccepted shares. Even such first right can be waived or modified – Sangramsinh P Gaekwad v. Shantadevi P Gaekwad AIR 2005 SC 809 = 57 SCL 476 (SC). In this case, it was also held that the offer of rights shares is an ‘invitation to offer’. A right to share would fructify only when an offer made by company is accepted. The offer is a personal right, which is not inheritable [In this case, the word used is ‘allotment’, but actually, it was only an offer].

1.1 When Rights Issue is Not Required

Rights issue is not necessary in following circumstances. [If rights issue is not necessary, offer can be made to others on private placement basis or public issue can be made].

Employees Stock Option – Issue can be made to employees under Employees Stock option Scheme as per prescribed conditions – section 62(1)(b) of Companies Act, 2013.

Exercise of Option Attached to Debenture or Loan – If an option was attached to debentures issued or loans raised by the company to convert such debentures or loans into shares in the company, rights issue is not required. However, the terms of issue of such debentures or loans containing such option should have been approved by a special resolution by the company in general meeting – section 62(3) of Companies Act, 2013.

Special Resolution by Members Not to Make Rights Issue – If shareholders pass a special resolution that shares may be offered to some of the existing shareholders, employees or other persons, rights issue is not necessary. Valuation of shares should be done by a registered valuer, subject to the compliance with the applicable provisions of Chapter III and any other conditions as may be prescribed – section 62(1)(c) of Companies Act, 2013 [The words in italics inserted w.e.f. 9-2-2018]

[Chapter III of Companies Act, 2013 make provisions relating to prospectus and allotment of securities].

Issue of shares to outsiders without special resolution is illegal and void – Westfort Hi-Tech Hospitals v. V S Krishnan (2007) 76 SCL 185 (Ker HC DB) – confirmed in V S Krishnan v. Westfort Hi-Tech Hospital Ltd. (2008) 83 SCL 44 (SC).

If Member Does Not Accept Rights Offer – If a member to whom shares are offered does not subscribe to rights issue within prescribed time, the offer is deemed to have been declined. A member may even prior to the time specified for closure of offer may intimate that he is not accepting the offer. In such case, the shares can be disposed of by the Directors. The terms of such disposal should not be disadvantageous to the shareholders and the company – section 62(1)(iii) of Companies Act, 2013.

Compulsory Conversion of Loan or Debentures by Government – If Government has given some loans or taken some debentures, Government can order that the loan or debentures be converted into shares of the company at a price considered reasonable by Government. In such case, making rights issue is not necessary – section 62(4) of Companies Act, 2013.

Nidhi Companies Need Not Make Rights Issue – Nidhi companies are exempt from provisions relating to making of rights issue – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

1.2 Issue of Shares by Private Company

A private company was not required to make rights offer under the Companies Act, 1956 (That relaxation is not provided under the 2013 Act).

1.3 Letter of Offer in Case of Rights Issue

Issue of prospectus is not required for rights issue of shares or debentures to existing members of debenture holders, even if the applicant has right to renounce the shares under section 62(1)(a)(ii) of Companies Act, 2013 – section 26(2)(a) of Companies Act, 2013 [corresponding to section 56(5)(a) of the 1956 Act].

As per section 62(1)(a) of Companies Act, 2013, company proposing to make a rights issue is required to send a letter of offer to members. Thus, offer of fresh shares to existing members is not treated as a ‘public issue’. Hence, the company is not required to issue ‘Prospectus’.

The offer letter may be dispatched through registered post, speed post or through electronic mode or courier or any other mode having proof of delivery to all existing members at least three days before opening of the issue [section 62(2) of Companies Act, 2013 – The words in italics inserted w.e.f. 9-2-2018]

In case of private company, this period of three days can be reduced if 90% of members give their consent in writing or by electronic means – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

The letter of offer informs the shareholders their right to subscribe to specified number of shares, in proportion to existing holding. The notice must specify the terms and conditions of offer, and right of renunciation, the time within which the offer must be accepted and other prescribed matters.

The time within which the offer should be accepted shall not be less than fifteen days or more than thirty days. If the offer is not accepted within prescribed period, it is presumed to have been declined – section 62(1)(ii) of Companies Act, 2013.

In case of private company, this period of fifteen or thirty days can be reduced if 90% of members give their consent in writing or by electronic means – MCA Notification dated 5-6-2015 issued under section 462 of Companies Act, 2013.

Reduction in Time Line for Rights Issue to Even Less Than 15 Days – As per section 62 of Companies Act, 2013, the time period for providing offer letter to the existing shareholders under rights issue process is between 15 days (now 7 days) to 30 days, beyond which the offer is deemed to be declined. This minimum time limit of 15 days can be reduced to lesser days, as may be prescribed – amendment to section 62(1)(a)(c) of Companies Act, 2013 w.e.f. 22-1-2021. [Reduced to 7 days as stated below].

As per rule 12A of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 11-2-2021, for the purposes of section 62(1)(a)(i) of Companies Act, 2013, the time period within which the offer shall be made for acceptance shall be not less than seven days from the date of offer.

Letter of Offer by Listed Company – If the company is a listed company, letter of offer must contain details as prescribed by SEBI. As per SEBI guidelines, adequate publicity should be given to the rights issue, so that even if a shareholder has not received the letter of offer, he can still apply for shares on plain paper.

1.4 Prospectus Not Required in Rights Offer Even With Right of Renunciation

Section 26(2)(a) of Companies Act, 2013 [Corresponding to section 56(5)(a) of the 1956 Act] clearly states that issue of prospectus is not necessary in rights issue whether with or without right of renouncement.

Section 62(1)(a) of Companies Act, 2013 [Corresponding to section 81 of the 1956 Act] states that company making rights issue should send a letter of offer.

Department has also clarified vide letter No. 8/81/56-PR dated 4-11-1957, that issue of rights share is a ‘domestic concern’ and hence issue or registration of prospectus is not necessary.

Thus, no prospectus is required for ‘rights issue’ to existing members, even if the members have right to renounce the rights to a third person, who may or may not be a member – same view in Vikram Singh Oberoi v. ROC (2020) 158 SCL 248 = 114 taxmann.com 512 (Mad HC), where it was observed that rights issue does not get converted into public issue even if many members had renounced their entitlement in favour of third parties.

1.5 Meaning of ‘Renunciation of Rights Offer’

If a shareholder is not interested in accepting the offer of additional shares, he can renounce the same in favour of any other person, who may not be member of the company.

Giving of such right of renunciation is mandatory, unless the Articles of the company provide otherwise. This right must be specified in letter of offer given to the shareholder. [Section 62(1)(a)(ii) of Companies Act, 2013].

Normally, ‘rights issue’ is at a price lower than the prevalent market price. A shareholder who may be short of funds can renounce his right to specified number of shares, by ‘selling’ his right to subscribe. He can subscribe to part of his rights and renounce (sell) the balance. This is permissible.

However, the right of renunciation is not available in case of private limited company as private company can restrict transfer of shares.

Resolution Can Specify that Renunciation Can Be Only in Favour of Existing Member – In V O John v. Catholic Syrian Bank Ltd. (2009) 90 SCL 351 (Ker HC DB), a special resolution was passed in general meeting that the renunciation can be only in favour of existing members. Such resolution was held as valid.

1.6 Application for Additional Shares in Rights Issue

Sometimes, some shareholders do not subscribe to the ‘rights issue’. They may not even renounce their right to a third person. In such cases, the Board of Directors can dispose of the un-subscribed shares in a manner which they think is most beneficial to the company, if resolution specifically authorises them to do so. They can allot the un-subscribed portion to any other person.

Normal practice followed by good companies is to ask the shareholders to apply for additional shares, over and above the shares allocable to them as a matter of right. The un-subscribed portion is allotted to the members who have applied for additional shares on an equitable basis and balance amount is refunded.

1.7 ‘Fractional Rights’ in Case of Rights Issue of Shares

Sometimes, rights issue may result in fractional rights e.g. assume that existing share capital is Rs. 150 lakhs and the company wants to issue further capital of Rs. 50 lakhs. Thus, each shareholder will be entitled to subscribe to fresh shares equal to 33.33% of his existing holding e.g. a person holding 300 shares will have right to subscribe to 100 fresh shares. However, a shareholder holding 100 shares will be entitled to only 33 shares and not 33.33 as a fractional share cannot be issued. A shareholder holding 50 shares can get right for only 16 and not 16.667 shares.

The offer of further shares should be offered to holders of equity shares, in proportion to the existing paid up capital, as nearly as circumstances admit. Thus, legally, such fractional rights can be ignored. However, this becomes unfair, particularly to small shareholders.

Hence, good and well managed companies usually permit consolidation of such ‘fractional rights’, so that person consolidating such fractional rights can subscribe for full shares. Sometimes, such fractional rights are consolidated and allotted by the company to others. The holders of such fractional rights are paid cash proportionately out of the proceeds. Since company cannot sell or buy its own shares, a person may be nominated by a company who will sell the consolidated shares and remit the sale proceeds proportionately after deducting expenses, to the individual shareholders.

Coupons for Fractional Rights – In case of listed companies, they must issue coupons for fractional certificates, unless company in general meeting decides otherwise or unless stock exchange agrees otherwise. Such coupons can be sold. A person can consolidate such coupons and apply for shares.

1.8 Issue of Rights Shares to Be Kept in Abeyance If Transfer of Shares Not Registered

As per section 59(4) of Companies Act, 2013, a public limited company can refuse to register a transfer if the proposed transfer is against provisions of Law.

As per section 58(1) of Companies Act, 2013, a private company can decline transfer in pursuance of powers under its articles.

Sometimes, there may be stay of Court on such transfer.

The question is what is the legal position if a public company does not transfer shares as the transfer is against any law or if there is stay from Court or a private company refuses proposed transfer as it is against Articles of the company.

Where any instrument of transfer of shares has been delivered to any company for registration and the transfer of such shares has not been registered by the company for any reason, the company shall keep in abeyance in relation to such shares, any offer of rights shares under section 62(1)(a) and any issue of fully paid-up bonus shares in pursuance of first proviso of section 123(5) – section 126(b) of Companies Act, 2013.

1.9 Issue of Rights Shares Under FEMA

FEMA provisions allow Indian companies to freely issue Rights/Bonus shares to existing non-resident shareholders, subject to adherence to sectoral cap, if any. However, such issue of bonus/rights shares has to be in accordance with other laws/statutes like the Companies Act, as applicable, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (in case of listed companies), etc.

The offer on right basis to the persons resident outside India shall be:

(a) in the case of shares of a company listed on a recognised stock exchange in India, at a price as determined by the company

(b) in the case of shares of a company not listed on a recognised stock exchange in India, at a price which is not less than the price at which the offer on right basis is made to resident shareholders – Annexure 4 para 1 of Consolidated FDI Policy Circular dated 7-6-2016.

Regulation 6 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 provides that a person resident outside India may purchase equity or preference shares or convertible debentures offered on right basis by an Indian company, as per specified conditions.

After rights issue, report should be submitted to regional office of RBI in form FC-GPR, where registered office of company is situated, within 30 days [Regulation 6B of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000].

2. ‘Preferential Allotment’ in Case of Fresh Issue of Securities

Preferential Offer means an issue of shares or other securities, by a company to any selected person or group of persons on a preferential basis. It does not include offer through public issue, rights issue, employee stock option scheme, employee stock purchase scheme, sweat equity shares, bonus shares or Global Depository Receipts (GDR) – Explanation to Rule 13(1) of Companies (Share Capital and Debentures) Rules, 2014.

‘Shares or Other Securities’ means equity shares, fully convertible debentures, partly convertible debentures, or any other securities, which would be convertible into equity shares at a later date – Rule 13(1)(ii) of Companies (Share Capital and Debentures) Rules, 2014.

Thus, the provisions do not apply to non-convertible debentures or preference shares.

Generally, preferential allotment is made to promoters, collaborators etc., without making offer to members on pro rata basis.

Special resolution in general meeting authorising Board to make preferential issue instead of a rights issue is required. Valuation of shares has to be done by registered valuers, subject to the compliance with the applicable provisions of Chapter III and any other conditions as may be prescribed – section 62(1)(c) of Companies Act, 2013, words in italics inserted w.e.f. 9-2-2018.

[Chapter III of Companies Act, 2013 make provisions relating to prospectus and allotment of securities].

Preferential Allotment in Case of Listed Company – In case of listed company, the pricing of preferential issue should be made as per SEBI guidelines. In case of unlisted company, pricing of preferential issue can be made as may be decided by Board of Directors. Other provisions and procedures are similar to issue by private placement.

Such increase by preferential allotment should be as per guidelines issued by Government of India, Ministry of Industry dated 10^th April, 1995, RBI guidelines dated 9th April, 1995 and 16th June, 1995 and SEBI guidelines dated 19-1-2000. Guidelines issued by SEBI are applicable to all preferential allotments in listed companies, while guidelines issued by RBI and Central Government are applicable only to foreign investment. Broadly, these guidelines are identical.

2.1 Preferential Allotment in Case of Public Unlisted Company or Private Company

Provisions are made in rule 13 of Companies (Share Capital and Debentures) Rules, 2014. [earlier, these were made in Unlisted Public Companies (Preferential Allotment) Rules, 2003].

These provisions apply to unlisted public company or private company. In case of listed public companies, provisions of SEBI regulations will apply.

The preferential issue shall company with provisions of section 42 of Companies Act, 2013 relating to private placement.

The issue should be authorised by Articles and special resolution. Company is required to make disclosures as specified – rule 13(2) of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 19-7-2016.

If the preferential issue is only to one or more of existing members, following are not applicable:

(a) Section 42 of Companies Act, 2013 relating to private placement will not apply

(b) filing of private placement offer letter in form PAS.4 with ROC is not required – first proviso to rule 13 of Companies (Share Capital and Debentures) Rules, 2014, inserted w.e.f. 18-3-2015.

Since presently provisions relating to registered valuer are not notified, valuation report shall be made by an independent merchant banker registered with SEBI or independent CA in practice having at least 10 years experience.

The price of such shares or securities issued on preferential basis shall not be less than the price determined on basis of valuation report.

The special resolution should be passed after making specified disclosures in the explanatory statement. The special resolution is valid for 12 months from date of passing.

If convertible securities are offered on preferential basis, value shall be determined upfront on basis of valuation report or on basis of valuation report at the time of conversion. The valuation report should not be earlier than 60 days of the date when holder of security becomes entitled to apply for shares, Disclosure should be made at the time of offer of convertible security – rule 13(2)(h) of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 19-7-2016.

Validity Period of Special Resolution – Special resolution should be acted within 12 months. Thus, if issue is not made within 12 months, fresh special resolution will be required.

Certificate from Auditor/PCS – Statutory auditors/practicing company shall certify that the issue of the instrument is being made in accordance with rules. The certificate shall be placed before the general meeting.

3. Bonus Shares

If a company is profit making, its accumulated profits and free reserves go on increasing. Thus, actual capital employed (i.e. share capital plus accumulated profit plus free reserves) is much higher than the share capital as reflected in the balance sheet. Hence, profits earned appear to be much higher compared to the share capital. Hence, part of accumulated profits and free reserves can be distributed among members as fully paid bonus shares.

A company may issue fully paid-up bonus shares to its members, out of:

(i) its free reserves

(ii) the securities premium account; or

(iii) the capital redemption reserve account [section 63(1) of Companies Act, 2013] – similar provision in Regulation 39(ii)(D) of Model Articles of Association Table F of Companies Act, 2013.

Bonus Shares Out of Securities Premium Account – Fully paid bonus shares can be issued out of securities premium account – section 52(2)(a) and 52(3)(a) of Companies Act, 2013 and Regulation 39(ii)(D) of the Table F of Companies Act, 2013.

Bonus Shares Out of Capital Redemption Reserve Account – If preference shares are redeemed out of profits, a sum equal to nominal amount of the shares to be redeemed are required to be transferred to capital redemption reserve account under section 55(2) of Companies Act, 2013. This capital redemption reserve account can be used to issue fully paid bonus shares to members – section 55(4) of Companies Act, 2013 and Regulation 39(ii)(D) of the Table F of Companies Act, 2013.

The capital redemption reserve arising out of buy back of securities can be utilised to issue fully paid bonus shares – section 69(2) of Companies Act, 2013.

No Bonus Out of Revaluation of Reserves – Bonus shares cannot be issued by capitalising reserves created by the revaluation of assets [proviso to section 63(1) of Companies Act, 2013] As per SEBI guidelines also, a listed company cannot use revaluation reserves to issue bonus shares.

SEBI Guidelines for Listed Companies – SEBI guidelines for issue of bonus shares should be followed by a listed company.

3.1 Conditions for Issue of Bonus Shares by Capitalising Profits or Reserves

Company can capitalise its profits or reserves for purpose of issue of bonus shares, if following conditions are fulfilled [section 63(2) of Companies Act, 2013]:

(a) it is authorised by its articles.

(b) it has, on the recommendation of the Board, been authorised in the general meeting of the company.

(c) Company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it.

(d) it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity and bonus.

(e) the partly paid-up shares, if any outstanding on the date of allotment, are made fully paid-up.

(f) company complies with such conditions as may be prescribed.

The wording of the provision is such that aforesaid conditions are required to be satisfied only if profits or reserves are to be capitalised. It can be argued that these conditions are not required to be satisfied if bonus shares are to be issued out of securities premium account or capital redemption reserve account.

However, really securities premium account or capital redemption reserve account is also ‘reserve’. Hence, these conditions should be satisfied [This is one of the examples in the Act of clumsy drafting].

3.2 Capitalisation of Profits

Capitalisation of profits is permitted under Regulation 82 of Model Articles Table F of Companies Act, 2013.

The sum capitalised cannot be paid in cash, but it can be used for following [Regulation 39(ii) of Model Articles of Association Table F of Companies Act, 2013]

(A) Paying up any amounts for the time being unpaid on any shares held by such members respectively (making partly paid shares as fully paid)

(B) Paying up in full, unissued shares of the company to be allotted and distributed, credited as fully paid-up, to and amongst such members in the proportions aforesaid (bonus shares)

(C) Partly in the way specified in sub-clause (A) and partly in that specified in sub-clause (B)

Securities Premium Account and Capital Redemption Account for Bonus Shares – A securities premium account and a capital redemption reserve account may be used for purpose of issue of fully paid bonus shares – Regulation 39(ii)(D) of Model Articles of Association Table-F of Companies Act, 2013.

3.3 Board to Act on the Basis of Ordinary Resolution in General Meeting

Bonus shares are first approved in the meeting of Board. Once bonus issued is announced on basis of Board resolution, the company cannot subsequently withdraw the same – Rule 14 of Companies (Share Capital and Debentures) Rules, 2014.

The company in general meeting, upon recommendation of Board, can pass following resolution as ordinary resolution:

(a) that it is desirable to capitalise any part of the amount for the time being standing to the credit of any of the company’s reserve accounts, or to the credit of the profit and loss account, or otherwise available for distribution; and

(b) that such sum (capitalised profit) be accordingly set free for distribution in the manner specified in Regulation 39(ii) amongst the members who would have been entitled thereto, if distributed by way of dividend and in the same proportions [Regulation 39(i) of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

After such ordinary resolution, Board can give effect to the resolution by doing all necessary acts [Articles 39(ii)(E) and 40 of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

Return of Allotment – After allotment, return of allotment has to be filed with ROC, as per procedure prescribed in rule 12 of Companies (Prospectus and Allotment of Securities) Rules, 2014 as amended on 20-1-2023.

3.4 Fractional Certificate or Payment of Cash

The ratio of issue of bonus shares may be such that some members may be entitled to fractional share.

In such case, the Board may make provisions in respect of such fractional entitlement:

(a) By the issue of fractional certificates or

(b) By payment in cash or

(c) Otherwise as it thinks fit [Regulation 40(ii)(a) of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

For this purpose, Board may authorise any person to enter into an agreement with the company for the allotment to the members additional shares credited as fully paid up. Alternatively, company can pay, on behalf of members to any unpaid amount on their existing shares [Regulation 40(ii)(b) of Model Articles of company limited by shares as contained in Table-F of Schedule I of Companies Act, 2013].

Such agreement is binding on the members.

Normally, such fractional rights are consolidated into shares and sold by the person authorised by the Board. The proceeds are then distributed among members in proportion to their fractional rights.

3.5 Effect of Issue of Bonus Shares

Bonus shares is an excellent way of bringing the paid up capital of the company in line with actual capital employed in the business. It broadens the capital base and improves image of the company.

Only fully paid bonus shares can be issued. Partly paid bonus shares cannot be issued, as it will create liability on members which they may not want.

Bonus shares are same as normal shares and members are entitled to get dividend on such shares. They can also sell the shares, if they wish. A bonus share is thought of as a gift from the company. In fact, a bonus issue simply divides the existing shares into smaller units e.g. assume that equity share capital of company is Rs. one crore and free reserves are Rs. 2.5 crores. The company is declaring dividend of 30%. If bonus shares in ratio of 1:1 are issued, the share capital will be Rs. 2 crores and free reserves will be reduced to 1.5 crores. Thus, actually, there is neither any cash payment to members nor any cash receipt from members. If market price of shares was Rs. 100 per share before issue of bonus shares, it will come down to Rs. 50 per share. Thus, the shareholder is neither a loser nor a gainer. If the company now declares 15% dividend, the shareholder will get the same amount which he was getting earlier.

Issuance of bonus shares is nothing but mere capitalisation of the profits of company in respect of which certificates are issued to the shareholders entitling them to participate in the amount of reserve but only as part of capital – Hunsur Plywood Works v. CIT (1997) 95 Taxman 460 = 229 ITR 112 (SC) – quoted with approval in Khoday Distilleries Ltd. v. CIT (2009) 176 Taxman 142 (SC), where it was held that there is no element of gift in a company issuing bonus shares.

In issue of bonus shares, there is no cash inflow. After issue of bonus shares, the paid up capital comes to more realistic levels. Dividend declared on increased capital appears more reasonable. It does not look very high. Really, bonus shares is only a book entry.

Issue of bonus shares is considered a sign of healthy company and company which issues bonus shares periodically is well appreciated in share market.

3.6 When Right to Bonus Crystallises

In Shri Gopal Paper Mills v. CIT AIR 1970 SC 1750 = 37 Comp Cas 240 = 77 ITR 543 (SC), it was held that shareholder becomes owner of shares on date of resolution. It is not necessary for issue of shares that a share certificate has to be given. It can be given later. Vesting of bonus shares takes place from date of company’s resolution and not from date of actual allotment.

3.7 Expenses in Issue of Bonus Shares Are Revenue Expenses

In CIT v. General Insurance Corporation (2006) 156 Taxman 96 (SC), it has been held that expenditure incurred in connection with bonus shares is revenue expenditure. – same view in Bombay Burmah Trading v. CIT (1984) 145 ITR 793 = 12 Taxman 178 (Bom HC).

Earlier, in Gujarat Steel Tubes v. CIT (1994) 210 ITR 358 (Guj), it was held that expenses incurred in issue of bonus shares are capital in nature and cannot be allowed as expenditure. – quoted and followed in CIT v. Bharat Vijay Mills (2002) 124 Taxman 60 (Guj HC DB). Now these decisions stand overruled.

3.8 Bonus Shares Cannot Be Issued Out of Revaluation Reserves

Proviso to section 63(1) of Companies Act, 2013 [Corresponding to section 205(3) of the 1956 Act] specifically prohibits issue of fully paid bonus shares by capitalising reserves created by revaluation of assets.

In the 1956 Act, there was no such specific prohibition.

3.9 Bonus Shares, Dividend Are Accretions to Pledged Stock

In Standard Chartered Bank v. Custodian 2000 AIR SCW 1443 = AIR 2000 SC 1488 = 25 SCL 221, it was held that if shares are pledged as security with bank, bonus shares, dividend and interest in respect of pledged securities would be accretion to the pledged stock and have to be regarded as forming part of pledged property. The accretion will remain with the pawnee and the accretion can be dealt with in the same manner as the pledged shares. [As per section 163 of Contract Act, accretions in respect of goods must be returned when the goods bailed are returned]. It was observed – ‘Bonus share is an accretion. A bonus share is issued when the company capitalised its profits by transferring an amount equal to the face value of the share from its reserve to the nominal capital. In other words, the undistributed profit of the company is retained by the company under the head of capital against the issue of further shares to its shareholders. Bonus shares have, therefore, been described as a distribution of capitalised undivided profit. A bonus share is a property which comes into existence with an identity and value of its own and capable of being bought and sold as such. Thus, bonus shares is an accretion.

3.10 Making Partly Paid Shares Fully Paid Up By Bonus Issue

As per Regulation 39(ii) of Table F of Companies Act, 2013, amount standing to credit of company’s reserve account, or to credit of profit and loss account or otherwise available for distribution, can be used for following:

(i) Making partly paid shares as fully paid

(ii) Issuing fully paid shares (termed as bonus shares) in proportion to their existing shareholding

(iii) Partly for making shares fully paid up and partly for issuing fully paid-up bonus shares.

This is also permitted under proviso to section 123(5) of Companies Act, 2013 [Corresponding to section 205(3) of the 1956 Act].

As per Regulation 39(3) of Table F of Companies Act, 2013, share premium account and capital redemption reserve can be utilised only for issue of fully paid bonus shares. In other words, these reserves cannot be used for making partly paid shares fully paid up. Other reserves and surplus profits can be used either for making partly paid fully paid up or issuing fully paid-up bonus shares.

3.11 Issue of Bonus and Rights Shares to be Kept in Abeyance if Transfer of Shares Not Registered

As per section 59(4) of Companies Act, 2013, a public limited company can refuse to register a transfer if the proposed transfer is against provisions of Law.

As per section 58(1) of Companies Act, 2013, a private company can decline transfer in pursuance of powers under its articles. Sometimes, there may be stay of Court on such transfer.

3.12 Income Tax Aspects of Bonus Shares

Where bonus shares are issued, they become capital assets of the shareholder. There is no tax payable when bonus shares are received by shareholder. However, capital gains tax is attracted if bonus shares are sold by shareholder. The cost of bonus shares will be taken as ‘Nil’ for calculation of capital gains, if the shares were acquired after 1-4-1981 – section 55 of Income Tax Act.

The crucial date for the purpose of reckoning the period of holding is the date on which bonus shares were issued and not the date of purchase of original shares which gave rise to bonus shares. – Explanation I(f) to section 2(42A) of Income Tax Act.

3.13 Bonus Debenture

In Astra Zeneca Pharma India Ltd., In re (2010) 97 SCL 51 (Karn HC), a scheme of issuing fully paid non-redeemable debentures from general reserves was approved.

3.14 Bonus Shares under FEMA

Regulation 6A of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 allows issue of bonus shares by Indian company to its non-resident shareholders. Original shares should have been acquired by shareholder as per rules/regulations. The bonus shares will be subject to same restrictions about repatriability as applicable to original shares.

After bonus issue, report should be submitted to regional office of RBI in form FC-GPR, where registered office of company is situated, within 30 days [Regulation 6B of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000]

4. Sweat Equity Shares

Sometimes, an employee/director may be having * know how or * rights in the nature of intellectual property rights (e.g. patent or copyright) or * providing value addition. In such cases, a new and relatively unknown company may not be in a position to reimburse him through cash. Instead the company may offer him equity shares. Such offer of equity in company also encourages employees to join a new and relatively unknown company and give his know-how. In absence of such incentive, a person may not be willing to leave job in a big and reputed company and join a relatively new and unknown company.

Sweat Equity is a reward for hard work done or using intellectual property for benefit of company. As per Black’s Law Dictionary, ‘sweat equity’ means financial equity created in property by the owner’s labour in improving property.

Statutory Provisions for Sweat Equity – Section 53 of Companies Act, 2013 [Corresponding to section 79A of the 1956 Act] makes provision of issue of ‘sweat equity’ to directors or employees. It is termed as ‘sweat equity’ as it is earned by ‘sweat’ by employees (i.e. by hard work). Though it is termed as ‘sweat equity’, the employees become happy and hence is ‘sweet equity’ for them.

‘Sweat equity shares’ means such equity shares as are issued by a company to its directors or employees at a discount or for consideration other than cash, for their providing knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called – section 2(88) of Companies Act, 2013 [Corresponding to Explanation II to section 79A(1) of the 1956 Act].

The provisions are as follows:

‘Sweat Equity Shares’ means equity shares issued by company to its employees or directors at a discount or for consideration other than cash.
The ‘consideration other than cash’ may be for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called. Thus, the right may be ‘Patent’ or ‘Copyright’ or it may be similar to patent or copyright.
Shares of a class which have already been issued only can be issued as ‘Sweat Equity Shares’ [section 54(1) of Companies Act, 2013]
Issue of ‘sweat equity shares’ should be authorised by a special resolution by the company in general meeting. The resolution should specify number of shares, current market price, consideration, if any and class or classes of directors or employees to whom the ‘sweat equity shares’ may be issued [section 54(1)(b) of Companies Act, 2013]
Omitted w.e.f. 7-5-2018. [Till 7-5-2018, section 54(1)(c) of Companies Act, 2013 provided that the sweat equity shares can be issued only one year after the company was entitled to commence business]
If the company is listed on stock exchange, ‘sweat equity’ shares can be issued as per regulations made by SEBI. If company is not listed on stock exchange, sweat equity shares will be issued in accordance with guidelines which may be prescribed by Central Government [section 54(1)(d) of Companies Act, 2013]
The ‘sweat equity shares’ have same limitations, restrictions and rights as are applicable to other equity shares. The holders of such shares shall rank pari passu with other equity shareholders – section 54(2) of Companies Act, 2013 [corresponding to section 79A(2) of the 1956 Act]

Provisions in Listed of Listed Companies – SEBI (Issue of Sweat Equity) Regulations, 2002 make provisions for issue of sweat equity to employees/directors of listed company.

Provisions in Case of Unlisted Company – An unlisted company can issue sweat equity shares by complying with provisions of rule 8 of Companies (Share Capital and Debentures) Rules, 2014. The explanatory statement should contain specified particulars. Special resolution is to be passed, which is valid for twelve months from date of resolution. Sweat equity shares cannot exceed 15% of existing paid up capital or shares of issue value of Rs five crores, whichever is higher. Total sweat equity shares cannot exceed 25% of paid up equity capital of company at any time. The sweat equity shares have lock in period of three years. The sweat equity shall be treated as part of managerial remuneration, if issued to manager and the consideration does not form part of assets of the company in balance sheet. Disclosure shall be made in report of Board of Directors. Register of sweat equity shares shall be maintained in form SH.3.

Special Provisions in Case of Startup Company – In case of startup company, it can issue sweat equity shares not exceeding 50% of its paid up capital upto ten years (till 5-6-2020 the words were ‘five years’) from date of incorporation or registration – second proviso to rule 8(4) of Companies (Share Capital and Debentures) Rules, 2014 inserted w.e.f. 19-7-2016 and amended on 5-6-2020.

Start-up company means company as defined in G.S.R. 127(E), dated 19-2-2019 issued by the Department for Promotion of Industry and Internal Trade [Amendment dated 5-6-2020].

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Issue of Shares Under Companies Act 2013 – Types | Definitions