As the financial markets have matured over the years, the financial community has come out with various types of innovative financial instruments such as equity shares, preference shares, bonus shares, promissory notes, bonds, debentures, bonus debentures, warrants, option contracts to name a few.
Bonus Debenture is an instrument which has been recently introduced by some of the Corporates but is still not known in the marketplace. It is an instrument which has some features similar to Debentures, some features similar to bonus shares and it also has some of its very own distinctive features.
Bonus Debentures as a term has not been mentioned specifically in either Company’s Act or Income Tax Act. The said article has taken inferences from the various provisions of the Acts to understand the legal impact and nuances of this financial instrument.Bonus Debentures
Bonus debentures are the debentures issued free of cost to the shareholders in proportion of their shareholding by capitalizing the amount of 'Reserves and Surplus’. These Debentures are redeemed after a specific period of time and interest is paid at the approved rate during its validity period. Bonus Debenture has a face value, an interest rate and a maturity period.Bonus Shares
A bonus share is a free share of stock issued to the eligible shareholders of the company in proportion to the shares he / she already owns. While the issue of bonus shares increases the total share capital of the Company, it does not change the net worth value of the Company. Further at the hands of the shareholder, the total number of shares held increases, but the percentage of shares held remains constant and the net investment value per share reduces.Bonus Shares V/s Bonus Debentures
|Bonus Shares||Bonus Debentures|
|Reduces the amount of Reserves and surplus, and Increases the amount of Share capital.||Reduces the amount of Reserves and surplus, and Increases the amount of Debt.|
|No Cash out flow.||Cash out flows i.e. Interest and principal amount to be paid on maturity.|
|No interest is paid||Shareholders get interest in all the years till the debentures are mature.|
|No Income tax Benefits.||Company gets advantage of tax as the interest on debenture is allowed as a deductible expense.|
|Dilution in the share value.||No Dilution in the Share value.|
|Net worth of the Company does not change||Net worth of the Company decreases|
Dividend vs. Bonus Debentures Dividend is the distribution of divisible profits by a company to its shareholders as per the provisions of Section 205 of the Companies Act 1956 and the Company is required to pay dividend distribution tax on the amount of dividend declared. Issue of Bonus Debentures is construed as deemed dividend and the Company is also required to pay dividend distribution tax on the value of the bonus debentures issued to the shareholders.
However, dividend involves immediate cash payout to the shareholders, while in the case of bonus debentures there is no immediate payment to the shareholders. The debentures are redeemed only after the maturity period which could be three to five years and during the validity period the shareholders receive interest at a fixed rate.Tax Treatment on issue of Bonus Debentures:
According to tax point of view allotment of bonus debentures would be treated as dividend. Since bonus debentures are issued out of the post-tax profit accumulated by the company, the company does not get any deduction in the income statement for the value of the debentures that have been issued.
Company pays a dividend distribution tax on the amount of bonus debentures issued.
In subsequent years, when the debentures are either sold or redeemed, the sale price or the redemption amount received by the debenture holder will not be taxable to the extent of the capital value of the debentures already taxed as dividend in the year of the issue of the bonus debentures. Only the additional appreciation will be taxed as capital gains
As there are no specific provisions for the issue of Bonus debentures under any of the Statutes in India, the same has been issued by the corporate through a scheme of the arrangement under Section 391 to Section 394 of the Companies Act, 1956. The issue involves a cumbersome legal process as it needs the approval of the High Court. In case where corporate have non-resident shareholders then even the requirements of RBI and FEMA need to be adhered too.Advantages to the share holder of Issue of Bonus Debentures:
The reserves that the company distributes belong to the shareholders. By issuing bonus debentures, the shareholders are entitled to interest in all the years till the debentures are redeemed or matured.
For the investors, the company definitely sends a strong signal about its future growth and benefits they are going to derive in terms of tax-free receipt of redemption amounts and also the yearly interest on debentures. Since the debentures would be considered deemed dividend, the investment cost of the debentures in the hands of the shareholders would be its face value.
A shareholder holding a single share of Rs 1 actually received a total sum of Rs 6.4 (redemption amount plus interest over the tenure), which amounts to a dividend of more than 600 per cent over a period of three years, and slightly less if the cash flows are discounted for time value of money;
As an immediate reaction, the share price of HLL increased by 8 per cent on the day of announcement, to close at Rs 230 on the BSE.
This exercise will help the company improve its return on equity and economic value added;
As there is no immediate cash outflow, this debenture issue would not impair the company’s ability to execute any acquisitions. It would still be able to utilize its excess cash over the next 2-3 years;
One way of offering "bonus'' without increasing the equity capital;
Company also benefits by getting the advantage of tax as the interest on debenture is tax deductible;
Bonus debentures do not dilute the share value like bonus shares and the company can take the advantage of leverage. Company defers cash outflow till the time it pays interest or redeems the debentures;