A bonus issue is the corporate equivalent of cutting the same cake into more slices: the shareholder's proportionate stake is unchanged, no fresh money enters the company, and yet new fully paid shares appear in the demat account. Chapter XI of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 — comprising Regulations 293, 294 and 295 — tells a listed issuer when it may capitalise its reserves, what it may capitalise from, and how fast it must finish. Layered on top sits Section 63 of the Companies Act, 2013, the parent statute. For the judiciary and CLAT-PG aspirant the topic rewards precision: the eligibility conditions, the prohibited sources, the “not in lieu of dividend” bar, and the once-announced-never-withdrawn rule are all favourite one-mark traps. This chapter grounds every proposition in the bare text and in the settled case law on the legal character of bonus shares.
What a Bonus Issue Is — And What It Is Not
A bonus issue is the allotment of additional fully paid-up equity shares to existing shareholders, free of cost, in a fixed ratio to their existing holding (say, 1:1 or 2:3), funded not by fresh subscription money but by capitalising the company's own accumulated reserves. The accounting movement is purely internal — an amount standing to the credit of free reserves, the securities premium account or the capital redemption reserve is transferred to the share capital account, and shares of equivalent face value are issued against it. Nothing leaves the company; nothing is received by the shareholder in cash.
The classic judicial description comes from the Supreme Court in Commissioner of Income-Tax, Bihar v. Dalmia Investment Co. Ltd., AIR 1964 SC 1464. The Court explained that when a company declares a bonus out of its undistributed, capitalised profits and allots unissued shares as fully paid in satisfaction of that bonus, those are bonus shares; the reserves are converted into capital, the money continues to be employed in the business as the company's proper capital, and there is no release of profits to the shareholders. The bonus does not increase the intrinsic worth of a member's holding — it merely splits the existing value over a larger number of shares, depressing the per-share market price proportionately.
This is why a bonus issue must be sharply distinguished from a rights issue (where the shareholder pays for the new shares at a discounted price) and from a dividend (where cash actually flows out). It also differs from a stock split, which divides existing shares by reducing face value without touching reserves at all. The starting point for any answer is this character: a bonus issue is a capitalisation of reserves, not a distribution. The wider statutory architecture is traced in our note on the introduction and object of the ICDR Regulations, and the full subject map sits on the SEBI ICDR hub.
The Two-Layer Statutory Architecture: Section 63 and Chapter XI
Bonus issues are governed by two instruments that must be read together. The first is Section 63 of the Companies Act, 2013, which applies to every company. The second is Chapter XI (Regulations 293–295) of the SEBI (ICDR) Regulations, 2018, which applies additionally to a listed issuer. Regulation 293 opens with the words “Subject to the provisions of the Companies Act, 2013 or any other applicable law” — an express acknowledgement that the SEBI conditions sit on top of, and do not displace, the Companies Act regime.
Section 63(1) permits a company to capitalise its profits or reserves for issuing fully paid-up bonus shares out of three sources only: its free reserves, the securities premium account, and the capital redemption reserve account; and it categorically bars an issue of bonus shares by capitalising reserves created by the revaluation of assets. Section 63(2) lays down the gateway conditions — authorisation in the articles, recommendation by the Board and authorisation in general meeting, no default in payment of interest or principal on fixed deposits or debt securities, no default in statutory dues of employees, partly paid shares made fully paid, and such other conditions as may be prescribed. Section 63(3) adds the cardinal prohibition: bonus shares shall not be issued in lieu of dividend.
Chapter XI of the ICDR Regulations mirrors and supplements this for listed companies. Because the two layers overlap, an examiner can legitimately ask the conditions under either the Companies Act or the ICDR Regulations — a strong answer cites both and notes that the listed issuer must satisfy the stricter, cumulative set. The SEBI conditions are the focus of this chapter, but Section 63 is never far away.
Regulation 293: Conditions of Eligibility for a Bonus Issue
Regulation 293 states that, subject to the Companies Act, 2013 or any other applicable law, a listed issuer is eligible to issue bonus shares to its members only if it satisfies five conditions:
(a) Authorisation by the articles. The articles of association must authorise the issue of bonus shares and capitalisation of reserves. Crucially, the regulation supplies its own cure: if there is no such enabling provision, the issuer must pass a resolution at a general body meeting to amend the articles to provide for capitalisation of reserves. The power must therefore exist or be created — it cannot be assumed.
(b) No default on debt. The issuer must not have defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it. The logic is creditor protection: a company that cannot service its borrowings should not be enlarging its equity base for the benefit of shareholders, who rank behind creditors.
(c) No default on employee statutory dues. The issuer must not have defaulted in respect of the payment of statutory dues of employees — specifically contribution to provident fund, gratuity and bonus. Employees, like lenders, are protected stakeholders whose dues take priority over a discretionary capitalisation exercise.
(d) Partly paid shares made fully paid. Any outstanding partly paid shares as on the date of allotment of the bonus shares must be made fully paid-up. This is the ICDR analogue of Section 63(2)(e) and prevents the anomaly of bonus shares (which are by definition fully paid) sitting alongside partly paid existing shares.
(e) No fugitive economic offender. None of the issuer's promoters or directors may be a fugitive economic offender within the meaning of the Fugitive Economic Offenders Act, 2018. This condition was inserted to deny capital-market facilities to entities controlled by absconding economic offenders, and it mirrors the disqualification running through the eligibility provisions for an initial public offer and a further public offer.
These five conditions are conjunctive — every one must be met. A common examination error is to treat them as illustrative or to add conditions (such as a minimum profitability) that the regulation does not contain.
Regulation 294(3): The Permitted — and Prohibited — Sources
The heart of bonus-issue law is the question of source. Regulation 294(3) provides that a bonus issue shall be made only out of (i) free reserves, (ii) the securities premium account, or (iii) the capital redemption reserve account — and that these must be built out of genuine profits or securities premium collected in cash. The same sub-regulation expressly bars one source: reserves created by the revaluation of fixed assets shall not be capitalised for a bonus issue.
The prohibition on revaluation reserves is the single most tested point. A revaluation reserve represents an unrealised, notional, book gain arising from marking up the carrying value of fixed assets; it is not backed by realised profit or by cash actually received. To capitalise such a reserve into share capital would be to issue equity against paper gains that may never materialise, misleading investors about the company's real net worth. The “collected in cash” qualifier for securities premium and “genuine profits” qualifier for free reserves drive home the same theme: the capital base must be supported by real value, not accounting fiction.
The definition of free reserves reinforces this. Under Section 2(43) of the Companies Act, 2013, “free reserves” means such reserves which, as per the latest audited balance sheet, are available for distribution as dividend; the proviso expressly excludes any amount representing unrealised gains, notional gains or revaluation of assets, and any change in carrying amount arising from measuring assets or liabilities at fair value. Thus even the parent statute funnels the same restriction. The Supreme Court's analysis in Bhagwati Developers (P) Ltd. v. Peerless General Finance & Investment Co. Ltd., (2013) 9 SCC 584, confirms that capitalisation of reserves to issue fully paid bonus shares is a legitimate conversion of the company's own funds into capital — the source must, however, be a reserve the law permits to be so capitalised.
A precise answer therefore lists the three permitted sources, attaches the “genuine profits / collected in cash” qualifier, and states the absolute bar on revaluation reserves.
Regulation 294(4): Bonus Shares Not in Lieu of Dividend
Regulation 294(4) provides, without prejudice to the source restrictions in sub-regulation (3), that bonus shares shall not be issued in lieu of dividends. This echoes Section 63(3) of the Companies Act, 2013 word for word in substance.
The rationale lies in the distinct legal character of the two acts. A dividend is a distribution of divisible profits — cash (or property) actually leaving the company and reaching the shareholder, who receives income. A bonus issue is a capitalisation — reserves frozen permanently into share capital, with nothing reaching the shareholder in realisable form. As the Supreme Court emphasised in Dalmia Investment (AIR 1964 SC 1464), on a bonus issue nothing goes out of the company's coffers and nothing comes into the shareholder's pocket; the profits are not released. To allow a company to discharge a declared dividend obligation by handing out bonus shares would let it convert a present income entitlement of the shareholder into locked-up capital without consent — defeating the shareholder's right to the declared distribution and blurring the income/capital line that tax and company law carefully police.
The principle that bonus shares are an accretion to capital rather than income in the shareholder's hands runs through the authorities, including the House of Lords' classic decision in Inland Revenue Commissioners v. Blott, [1921] 2 AC 171, which held that profits capitalised and distributed as bonus shares are received by the shareholder as capital, not as income. Indian courts have consistently followed this characterisation. The “not in lieu of dividend” bar is the statutory crystallisation of that distinction.
Regulation 294(1)-(2): Reservation for Convertible-Instrument Holders
A bonus issue made only to current equity holders would dilute the future entitlement of those who hold instruments convertible into equity — because, on conversion, they would receive shares carved out of a capital base that has meanwhile been enlarged by a bonus the equity holders enjoyed but they did not. Regulation 294(1) addresses this. It permits a listed issuer to make a bonus issue of equity shares only if it has made a reservation of equity shares of the same class in favour of the holders of outstanding compulsorily convertible debt instruments, in proportion to the convertible part thereof.
Regulation 294(2) completes the mechanism: the equity shares so reserved for holders of fully or partly compulsorily convertible debt instruments are to be issued to them at the time of conversion of those instruments (or warrants), on the same terms or in the same proportion at which the original bonus shares were issued. In effect, the convertible holder is placed in the same position as if she had already converted and participated in the bonus.
The provision implements a basic fairness principle: a class of stakeholders with a contingent but compulsory route into equity must not be prejudiced by a capitalisation timed to occur before their conversion. The definitional contours of “convertible securities” and “equity shares” that this regulation relies upon are set out in our note on definitions and scope under the ICDR Regulations. Sub-regulation (5), added later, deals with the special case of superior-voting-rights (SR) equity shares, requiring that any bonus on SR shares carry the same voting-rights ratio and that SR shares issued in a bonus convert to ordinary voting equity along with the existing SR shares.
Regulation 295: Completion and the No-Withdrawal Rule
Regulation 295 governs timing and finality. It draws a clean distinction based on whether shareholder approval is required for the capitalisation:
Fifteen days — board-only approval. Where an issuer announces a bonus issue after approval by its Board of Directors and does not require shareholders' approval for capitalising the profits or reserves, it must implement the bonus issue within fifteen days from the date of the Board's approval. This will typically be the case where the articles already authorise capitalisation and the Board is empowered to act.
Two months — shareholder approval needed. Where the issuer is required to seek shareholders' approval (for example, where the articles must first be amended to permit capitalisation), the bonus issue must be implemented within two months from the date of the Board meeting at which the decision to announce the bonus — subject to shareholders' approval — was taken.
The Explanation to Regulation 295 is itself examinable: for the purpose of treating a bonus issue as “implemented”, the relevant date is the date of commencement of trading of the bonus shares — not merely the date of allotment or credit. Implementation is thus measured by the moment the new shares are actually tradable on the exchange.
Regulation 295(2) lays down the cardinal finality rule: a bonus issue, once announced, shall not be withdrawn. The moment the Board announces the bonus, the company is committed; it cannot reconsider, defer indefinitely or cancel. This protects the integrity of price-sensitive disclosure — a bonus announcement moves the market, and permitting withdrawal would invite manipulation and unfair trading on a decision that was never genuinely final.
Why a Bonus Once Announced Cannot Be Withdrawn
The no-withdrawal rule in Regulation 295(2) deserves separate treatment because it is conceptually distinct from the eligibility and source conditions. Those conditions operate before the issue; the no-withdrawal rule operates after the announcement to freeze the issuer's discretion.
A bonus announcement is unambiguously price-sensitive information. On announcement, the market begins to price the stock on an ex-bonus basis — the per-share price adjusts downward to reflect the larger share count to come, and investors transact in anticipation of receiving the bonus shares. If the issuer were free to withdraw, it could announce a bonus to prop up sentiment or to trade advantageously, then quietly retract once its objective was served, leaving investors who bought on the announcement holding shares at an artificially set price. The rule therefore enforces commitment: the announcement is treated as an irrevocable corporate act.
This dovetails with the general disclosure philosophy of the ICDR framework — that information released to the market must be reliable and acted upon, a theme explored in our note on disclosure in the draft red herring prospectus. Note also the interplay with Section 63: although the Companies Act does not in terms forbid withdrawal, Rule 14 of the Companies (Share Capital and Debentures) Rules, 2014 likewise provides that a bonus once recommended by the Board shall not be subsequently withdrawn. The two regimes are aligned. For a listed issuer, Regulation 295(2) is the operative, harder-edged prohibition.
The Legal Character of Bonus Shares in the Case Law
The jurisprudence on bonus shares is overwhelmingly tax-driven, but it settles principles a corporate-law answer must deploy. The foundational Indian authority is Commissioner of Income-Tax, Bihar v. Dalmia Investment Co. Ltd., AIR 1964 SC 1464. There the Supreme Court analysed the true nature of a bonus issue and held that capitalisation of reserves followed by allotment of fully paid bonus shares does not put fresh funds into the company or release profits to shareholders — the reserves merely change their legal label from distributable profit to permanent capital. For valuing bonus shares held as stock-in-trade, the Court endorsed the averaging method, spreading the original cost over the enlarged holding where the shares rank pari passu.
The English fountainhead is Inland Revenue Commissioners v. Blott, [1921] 2 AC 171, where the House of Lords held that where a company capitalises profits and issues bonus shares, the shareholder receives capital, not income — the profits are not divided but converted into the company's fixed capital. Indian courts adopted this reasoning early and consistently, treating bonus shares as an accretion to the shareholder's capital asset rather than a taxable receipt of income.
The Supreme Court returned to the theme in Bhagwati Developers (P) Ltd. v. Peerless General Finance & Investment Co. Ltd., (2013) 9 SCC 584, in the context of a company's power to issue bonus shares by capitalising reserves; the Court affirmed that such capitalisation is a recognised and legitimate corporate act, the bonus shares representing reserves converted into capital rather than any distribution to members. Read together, these decisions supply the analytical spine for any discussion of why the ICDR source and “not in lieu of dividend” restrictions take the shape they do: because a bonus issue is, in law, a capitalisation, the law confines it to reserves that can properly be capitalised and forbids its use as a disguised distribution.
Interplay with the Companies Act and Other Regulations
Because Regulation 293 is expressly “subject to” the Companies Act, a listed issuer must clear both gateways. In practice the conditions substantially overlap: authorisation by articles (Reg 293(a) / s.63(2)(a)), no default on deposits or debt securities (Reg 293(b) / s.63(2)(c)), no default on employee statutory dues (Reg 293(c) / s.63(2)(d)), partly paid shares made fully paid (Reg 293(d) / s.63(2)(e)), prohibition on revaluation reserves (Reg 294(3) / s.63(1) proviso), and the “not in lieu of dividend” bar (Reg 294(4) / s.63(3)). The ICDR adds two distinctly capital-market conditions — the fugitive-economic-offender disqualification (Reg 293(e)) and the reservation for compulsorily convertible instrument holders (Reg 294(1)-(2)) — together with the hard timelines and the no-withdrawal rule (Reg 295).
Bonus shares also interact with other parts of the ICDR Regulations. For minimum promoters' contribution and the lock-in regime, securities arising out of a bonus issue against locked-in shares (or out of revaluation reserves or unrealised profits) are treated specially — a point developed in our note on promoters' contribution and lock-in. The continuous-disclosure obligations of the SEBI (LODR) Regulations, 2015 also bite: a bonus announcement is a material event requiring prompt intimation to the exchanges, and the record date must be fixed and notified in accordance with the listing agreement. A complete answer therefore situates Chapter XI within this wider web rather than treating it in isolation.
Procedure in Outline: From Board Meeting to Trading
While the regulations prescribe conditions rather than a step-by-step procedure, the practical sequence is worth knowing for problem questions. First, the issuer confirms that the articles authorise capitalisation; if not, it convenes a general meeting to amend them (Reg 293(a)). Second, the Board meets to recommend the bonus ratio and, critically, to fix or recommend the record date; this Board meeting is the trigger for the Regulation 295 clock. Third, depending on whether shareholder approval is needed, the issuer either implements within fifteen days (board-only) or within two months (after the meeting where the subject-to-approval decision was taken). Fourth, the company ensures the chosen source — free reserves, securities premium collected in cash, or capital redemption reserve — is adequate and is not a revaluation reserve (Reg 294(3)). Fifth, partly paid shares are made fully paid (Reg 293(d)) and reservation is made for compulsorily convertible holders (Reg 294(1)).
Finally, the bonus shares are allotted in dematerialised form and admitted to trading; implementation is complete only on the date of commencement of trading (Explanation to Reg 295). Throughout, the company may not withdraw the announced bonus (Reg 295(2)), and it must keep its disclosure obligations current. The eligibility discipline that governs other capital-raising routes — for instance the conditions for a further public offer — reflects the same regulatory instinct: capital must be issued only where the issuer's house is in order.
Common Examination Pitfalls
First, candidates routinely add a profitability or net-worth precondition to Regulation 293 — there is none. The conditions are the five listed (articles, no debt default, no employee-dues default, partly paid made fully paid, no fugitive economic offender), plus the Companies Act conditions. Second, the most common single-mark slip is forgetting that revaluation reserves cannot be capitalised — this is tested almost every cycle and is reinforced by both Reg 294(3) and the s.2(43) definition of free reserves.
Third, candidates confuse the two timelines: fifteen days is for board-only approval, two months is where shareholder approval is required. Reversing them costs the mark. Fourth, the trigger for the two-month period is the date of the Board meeting at which the subject-to-approval decision was taken — not the date of the general meeting. Fifth, “implemented” means date of commencement of trading, not date of allotment. Sixth, the no-withdrawal rule applies the moment a bonus is announced, and it is absolute — there is no “reasonable cause” exception in Regulation 295(2). Keeping these six distinctions crisp converts a vague answer into a scoring one.
Frequently asked questions
What are the permitted sources for a bonus issue under SEBI ICDR Regulations, 2018?
Under Regulation 294(3), a bonus issue may be made only out of (i) free reserves, (ii) the securities premium account, or (iii) the capital redemption reserve account, and these must be built out of genuine profits or securities premium collected in cash. Reserves created by the revaluation of fixed assets cannot be capitalised. This mirrors Section 63(1) of the Companies Act, 2013, whose proviso likewise bars revaluation reserves.
Can bonus shares be issued in lieu of dividend?
No. Regulation 294(4) of the ICDR Regulations and Section 63(3) of the Companies Act, 2013 both prohibit issuing bonus shares in lieu of dividends. A dividend is a distribution of profits that reaches the shareholder as income, whereas a bonus issue is a capitalisation of reserves where, as the Supreme Court explained in CIT v. Dalmia Investment Co. Ltd. (AIR 1964 SC 1464), nothing leaves the company and nothing reaches the shareholder in realisable form.
What are the eligibility conditions for a listed issuer to make a bonus issue?
Regulation 293 requires that the issue be authorised by the articles (or the articles be amended by a general-meeting resolution), that the issuer has not defaulted on interest or principal of fixed deposits or debt securities, has not defaulted on employee statutory dues such as provident fund, gratuity and bonus, has made any outstanding partly paid shares fully paid by the allotment date, and that none of its promoters or directors is a fugitive economic offender. These are conjunctive and read alongside Section 63 of the Companies Act, 2013.
Within what time must a bonus issue be completed?
Under Regulation 295(1), where no shareholders' approval is required for the capitalisation, the bonus must be implemented within fifteen days of the Board's approval. Where shareholders' approval is required, it must be implemented within two months from the date of the Board meeting at which the decision to announce the bonus (subject to shareholders' approval) was taken. By the Explanation, a bonus is treated as 'implemented' on the date of commencement of trading of the bonus shares.
Can a company withdraw a bonus issue once announced?
No. Regulation 295(2) provides categorically that a bonus issue, once announced, shall not be withdrawn. The rule protects the integrity of price-sensitive disclosure, since a bonus announcement moves the market and investors transact in reliance on it. Rule 14 of the Companies (Share Capital and Debentures) Rules, 2014 contains a parallel bar under company law.
What is the legal character of a bonus share in the shareholder's hands?
A bonus share is an accretion to the shareholder's capital, not income. In IRC v. Blott [1921] 2 AC 171 the House of Lords held that capitalised profits distributed as bonus shares are received as capital, and the Indian Supreme Court adopted this in CIT v. Dalmia Investment Co. Ltd. (AIR 1964 SC 1464), holding the reserves are converted into permanent capital with no release of profit. Bhagwati Developers (P) Ltd. v. Peerless General Finance & Investment Co. Ltd. (2013) 9 SCC 584 reaffirmed that such capitalisation is a legitimate corporate act.