The question of bonus shares and dividends has always been a tricky one, for company and investors alike. If you too are troubled by the same, you are at the right place find your answers.
What is a bonus
A bonus or bonus issue is when the company decides to issue more shares out of the current profits of the company. These shares are awarded to the existing shareholders only, without them paying any cost. The company fixes a ratio at which bonus shares are issued. For example, the bonus ratio can be 1:1, implying that an existing shareholder with 1 share will receive another bonus share on the day of the announcement. Issuing bonus shares is an easy way to capitalize the reserves of the company.
What is dividend
Dividends are significant for every investor. It is that part of the company’s profit which is given to the shareholders. Dividends are the reward that the investor gets for investing their money in the company. A percentage of dividends is decided at the end of the term by the company, which are then distributed among the holders. For example, if a share has the face value of Rs. 100, and the dividends declared are 10%, then Rs. 10 will be given on every share held by the investor.
The company is never obligated to pay dividends, even if they have earned profits. It depends entirely upon the discretion of the Board of Directors.
Every company is subjected to a wide array of taxes. So, if you are guessing whether the company pays tax on dividends and bonus, then you are right. Let us see how it works.
Bonus shares: A company can issue bonus shares from the reserves or the accumulated profits of the current or previous years. It is done to increase the capital and marketability of the shares. The issue of bonus shares being down the earnings per share and hence the market price of the shares go down.
A company does not have to pay tax on the issue of bonus shares. However, if the shareholder plans to sell or purchase bonus shares, it is liable to tax. All the incomes arising from securities are taxable under the head Capital Gains, according to the Income Tax Law of India. The capital gain can be of two types, short term or long term. Short term capital gain arises when bonus shares are held for less than or equal to 12 months, and the corresponding tax rate is 15%. A long term capital gain is when shares are held by the investor for over 12 months, and such incomes not liable to tax under section 10 of the act.
Dividends: When a company wishes to declare dividends to the shareholders, the company has to pay dividend distribution tax. The dividend distribution tax or DDT is levied on the earnings of the company. Currently, 15% of DDT is levied on the company. As per the instructions of Indian Government, if a company wishes to declare dividends to the existing shareholders, the company is required to transfer 15% on the gross amount of dividend. It is also subjected to a surcharge and cess, over the rate of 15%, so the total percentage to be paid as DDT amounts to 17.65 percent. This amount of tax must be deposited within a period of 14 days of the announcement, and on delay, the company is liable to pay interest at 1% of the amount of tax.
For example, if a company generates a profit of Rs. 1000, the company is liable to pay 30% as Income Tax.
So, Profit = Rs. 1,000, Incone Tax = Rs. 300 (30%), the residual profits will amount to Rs. 700.
Out of the 700 if the company decides to distribute 400 rupees as dividends, Rs. 300 goes into reserves.
The gross dividend distribution tax at Rs. 400 will be levied at 15%. Hence, the amount of tax will be Rs. 60.
Therefore, the total transaction pans out as follows:
Profits = Rs. 1,000
Tax = Rs. 300 + Rs. 60
Dividends = Rs. 400 – Rs. 60 = Rs 340
Reserves = Rs. 240
To arrive at the dividends given on per share, this amount of Rs. 340 is divided by the total number of shares of the company.
Since now the tax implications from the company’s perspective are clear, let’s check it from investor’s point of view. The dividend income in the hand of an investor is not liable to tax, up to a certain limit. If the investors earn total dividends over and above a total of 10 lakhs, the total dividend income is liable to a tax of 10%. Only the dividends given by domestic or Indian companies are exempt, whereas the ones given by foreign companies to Indian investors are liable to tax. If the tax is already paid the country of origin, then the investor can claim for a refund later on.
It is clearly ascertained that bonus shares have relatively minor complications and tax implications, hence are preferred over dividends by the companies. Similarly for the investors also, issue of bonus shares is much better. On a quick glance, following are the major points of difference that gives bonus shares a priority:
- Tax saving is the first and foremost criteria. A company has to pay dividend distribution tax on the issue of dividends whereas no such tax is to be paid by the company on bonus since they are treated as an issue of new shares. Even for the investors, bonus shares only incur tax on short term capital gains, in the rare case of sale within a year. All of this contributes to make bonus shares a better alternative among the two.
- A company is not liable to pay dividends to the shareholders. As per the Companies Act of 2013, a company is required to pay dividends only in the year that has substantial profits at the end, even then it is upon the decision of the Board of Directors. However, a company can give bonus shares even if they have incurred losses. It is so because the issue of bonus shares can be done out of the current profits and accumulated reserves of the past years. By this, the shareholders can be satisfied even if there are no profits in the current period.