The Hindu Business Line : Split and run, or bag a bonus and wait

There is much hair-splitting on the relative benefits of a bonus issue vis-à-vis a share split. An investor with a short-term outlook may benefit by a split, while one willing to wait may prefer a bonus issue.

The news about bonus issues or share splits is normally received positively by shareholders. The same goes for units of mutual funds. Bonus or split in units is normally done when the Net Asset Value (NAV) of the fund is at respectable levels. Similarly, normally, corporates announce bonus or split when the share price goes to a respectable level and the management sees bright prospects for profitability and net worth.

Earlier, Section 94 of the Companies Act allowed issue of bonus shares only. The action of splitting a share was inserted in the Act later on. Issue of bonus shares is governed by specific rules, which insist on adequate reserves; in the balance-sheet, issue of bonus shares is in fact capitalisation of reserves.

With splitting of paid-up capital allowed, corporates started doing it without touching the reserves. This way they could limit the paid-up capital value even while increasing the liquidity of shares in the market, which is always desirable.

The Balance-Sheet perspective

Rewarding by bonus shares means actual capitalisation of reserves. Rewarding by split does not mean anything from the balance-sheet perspective. It only increases the liquidity of stock by reducing the paid-up capital.

If the corporate comes up with further new share issues, by way of private placement, the lower base of the paid-up capital and the higher percentage stake of new investors can be attractive features if the capital has only been split.

If expanded by bonus shares, then, the existing shareholders would already have a higher stake vis-à-vis further new issue size. Of course, the equity dilution will be lower in that case.

As per Section 55 of the Income-Tax Act, bonus shares entail zero costs while all the purchase cost can be loaded on to the original shares.

A split apportions the cost of acquisition in the split ratio. For bonus shares, the one-year holding requirement for Long-Term Capital Asset (LTCA) eligibility starts from the allotment date of bonus shares.

In the case of split, the one-year eligibility is along with the original form of capital, which is split. In other words, the one-year does not start on the split date but on the date of purchase of original shares.

Which is better?

When does the shareholders benefit — by bonus or by split?

For a long-term investor, neither options makes a difference. Relative benefit on either option may get neutralised over time. In case of further shares issue by way of private placement, the equity dilution may be less had shareholders been rewarded with bonus issues.

However, much depends on the pricing and the premium parts of the issue.

An investor with a short-term outlook may benefit by a split rather than a bonus issue. Shares after split are recognised as LTCA if originally these have been held for one year.

However, in the case of bonus issues, the new shares need to be held for one year to become LTCA. There is normally a limit up to which shares can be split.

Also, splitting is not an active decision of balance-sheet restructuring but meant more to show a higher number of shares in trading. Bonus share issues really require adequate reserves as per the relevant Rules.

Periodic bonus announcements show up the real strengths of a company — in building up reserves, in its profit model and, of course, in the intention to reward. Further, splitting is more beneficial to short-term stakeholders, while bonus shares are more for long-term stakeholders.

Is it the same for mutual fund investors?

Both bonus shares and split have to do something with the "liquidity" factor. "Liquidity" is relevant only for listed close-ended mutual funds.

The position of an investor in a listed, close-ended mutual fund scheme is the same as that of a corporate investor.

However, for an unlisted open-ended mutual fund, "liquidity" is not an issue at all. What matters more is the "tax efficiency of the investment decision".

An investor owns a fund, a dynamic portfolio and, hence, is not attached to the profitability models or the businesses of underlying securities in the portfolios.

An investor is concerned more with the overall tax-efficiency of his investment planning. Hence, splitting may make more sense for open-ended unlisted mutual fund investors.

Again, for a long-term investor in equity, relative expected benefit from either decision is neutralised over the time.

(The writer works for a leading mutual fund. The views are personal.)

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