Introduction

The structure of a company’s share capital reflects both its financial strength and its relationship with shareholders. Capital structure management plays a critical role in balancing profitability, investor confidence, and corporate governance. Among the many mechanisms available to companies for restructuring or reorganising their capital, the issue of bonus shares and the reduction of share capital are particularly significant. These two concepts, though operating in opposite directions, share a common purpose — to align the company’s paid-up capital with its actual financial position and business objectives. While the issue of bonus shares is a method of capitalisation of reserves and represents distribution of accumulated profits in the form of shares, reduction of share capital involves decreasing the company’s capital base to reflect losses, eliminate over-capitalisation, or restructure equity.

The Companies Act, 2013, together with judicial precedents and regulatory provisions issued by the Securities and Exchange Board of India (SEBI), governs both these corporate actions in India. The present discussion analyses these two mechanisms in detail, highlighting their legal provisions, rationale, procedural requirements, limitations, and judicial interpretations.

Part I – Issue of Bonus Shares

Concept and Legal Nature

Bonus shares are additional shares issued by a company to its existing shareholders free of cost, out of the company’s accumulated reserves or surplus. Essentially, they are a conversion of the company’s retained earnings into paid-up share capital. The issue does not result in inflow of new funds into the company; rather, it represents a reallocation within the shareholders’ equity section of the balance sheet. The issuance of bonus shares does not alter the proportionate ownership of the shareholders; every shareholder receives shares in the same ratio as his existing holdings.

The issue of bonus shares is primarily governed by Section 63 of the Companies Act, 2013, which replaced Section 205(3) of the Companies Act, 1956. The statutory intent is to regulate the circumstances and the source from which bonus shares can be issued and to ensure that such issuance is based on real, not illusory, profits. The provision makes it clear that the company can issue fully paid bonus shares to its members out of (a) its free reserves, (b) the securities premium account, or (c) the capital redemption reserve account. It also expressly prohibits the issue of bonus shares out of revaluation reserves.

Rationale and Corporate Purpose

The issue of bonus shares serves multiple economic and financial purposes. First, it allows companies with large accumulated reserves to capitalise a portion of these reserves, thereby adjusting the relationship between paid-up capital and distributable profits. Second, it sends a positive signal to the market that the company is financially strong, which may increase investor confidence. Third, by increasing the number of outstanding shares, it can reduce the market price per share, improving liquidity and affordability for investors. Fourth, it represents a form of reward to shareholders in the form of additional shares instead of cash dividends.

Statutory Framework under Section 63

Section 63(1) of the Companies Act, 2013 stipulates that a company may issue fully paid-up bonus shares to its members, in any manner whatsoever, out of its free reserves, the securities premium account, or the capital redemption reserve account. The provision requires that the issue of bonus shares must be authorised by the articles of association of the company. If such authorisation is absent, the company must first alter its articles under Section 14 of the Act. The decision to issue bonus shares must be recommended by the Board of Directors and approved by the shareholders in a general meeting.

Sub-section (2) of Section 63 imposes restrictions and conditions on the issue of bonus shares. It provides that no company shall capitalise its profits or reserves for the purpose of issuing fully paid bonus shares unless (a) it is authorised by its articles; (b) it has, on the recommendation of the Board, been approved in the general meeting; (c) it has not defaulted in payment of interest or principal on any fixed deposit or debt security issued by it; (d) it has not defaulted in payment of statutory dues of employees; and (e) partly paid-up shares, if any, have been made fully paid before the issue of the bonus shares.

Sub-section (3) further provides that the bonus shares shall not be issued in lieu of dividends. This means that the company cannot issue bonus shares to avoid paying dividends; rather, they can only be issued as capitalisation of existing reserves.

Procedural Aspects

In practice, the process of issuing bonus shares begins with a decision of the Board of Directors, who assess the company’s financial position and decide the ratio of bonus shares to be issued. The Board passes a resolution recommending the issue, specifying the source from which the shares will be issued, and calling a general meeting for shareholder approval. After shareholder approval, the company files the relevant forms with the Registrar of Companies and amends its memorandum and articles of association, if necessary, to reflect the increased paid-up share capital.

For listed companies, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 impose additional requirements, including prior intimation to the stock exchanges, fixing of record date, and post-issue compliance. Once the bonus shares are allotted, the company must credit the new shares to shareholders’ dematerialised accounts and make appropriate disclosures in its balance sheet.

Accounting and Tax Treatment

The accounting treatment of bonus shares is governed by Accounting Standard (AS)-20 or Ind AS-33 in India. The reserves from which the bonus issue is made are reduced by the corresponding amount, and the paid-up share capital is increased by the same amount. From the company’s perspective, the total shareholders’ funds remain unchanged; there is merely a reclassification within equity. From the shareholder’s perspective, the cost of acquisition of each share is adjusted proportionately for capital gains purposes.

Bonus shares are not taxable as income in the hands of shareholders at the time of issue, since no consideration is received by the company and it constitutes capital receipt. However, when the shares are sold, the capital gains are computed by spreading the cost of acquisition over the original and bonus shares.

Judicial Interpretations and Case Law

Indian courts have consistently upheld the principle that the issue of bonus shares is a legitimate corporate action provided the company complies with statutory conditions. In the leading case of CIT v. Dalmia Investment Co. Ltd. (1964 AIR 564), the Supreme Court observed that bonus shares are essentially a reallocation of the company’s capital structure and not distribution of profits as income. Similarly, in CIT v. G. Narasimhulu (1973 88 ITR 336 AP), the Andhra Pradesh High Court reiterated that a bonus issue does not involve any inflow of funds into the company and therefore is a mere conversion of reserves into capital.

Judicial scrutiny has also extended to cases of alleged misuse of bonus issues. In Rustom Cavasjee Cooper v. Union of India (1970 1 SCC 248), the Supreme Court observed that the bonus issue must be made in accordance with bona fide financial considerations and cannot be used as a device to manipulate shareholding or evade dividend obligations.

Corporate Governance and Investor Protection

Bonus issues often have significant market impact and can affect investor perception. Therefore, corporate governance standards require full transparency. The company must disclose the rationale for the issue, its impact on reserves, and its effect on the paid-up capital. Directors must ensure that the company’s financial statements reflect the true and fair value of reserves being capitalised. The prohibition against issuing bonus shares out of revaluation reserves or unrealised profits serves as a safeguard against cosmetic enhancement of capital.

Part II – Reduction of Share Capital

Concept and Need for Reduction

While bonus shares represent an increase in paid-up capital through internal adjustments, reduction of share capital represents the opposite — a deliberate decrease in the company’s capital base. Reduction of share capital is a mechanism that enables a company to realign its capital structure when it becomes over-capitalised, or when it has suffered capital losses that cannot be recouped through profits. It is also used in restructuring exercises, mergers, and buy-backs.

The principle underlying reduction of capital is that shareholders may agree, subject to legal safeguards, to release or cancel part of their rights in the company’s capital, provided the creditors’ interests are protected. Since capital serves as a cushion for creditors, reduction of capital is strictly regulated by law and requires approval of both shareholders and the National Company Law Tribunal (NCLT).

Statutory Framework under Section 66

Section 66 of the Companies Act, 2013 lays down the legal procedure for reduction of share capital. It provides that, subject to confirmation by the Tribunal, a company limited by shares or limited by guarantee having share capital may, by special resolution, reduce its share capital in any manner and in particular by (a) extinguishing or reducing the liability on any of its shares in respect of unpaid share capital; (b) either with or without extinguishing or reducing liability on any of its shares, cancelling any paid-up share capital which is lost or unrepresented by available assets; or (c) paying off any paid-up share capital which is in excess of the wants of the company.

This provision is substantially similar to Section 100 of the Companies Act, 1956 but includes modernised procedural safeguards and empowers the NCLT, which replaced the High Court’s jurisdiction.

Procedural Requirements

The process begins with the company passing a special resolution in a general meeting approving the reduction. Following the resolution, the company must apply to the Tribunal for confirmation. The application must be accompanied by a list of creditors, their consent, and a declaration by the company’s directors affirming that the reduction does not prejudice creditors or shareholders.

Upon receipt of the application, the Tribunal issues notices to the Central Government, the Registrar of Companies, and the creditors inviting objections. The Tribunal may dispense with the requirement of creditor consent if the company can demonstrate that its debts are fully settled or secured. After considering all objections and ensuring that creditors’ interests are safeguarded, the Tribunal may confirm the reduction, subject to conditions. The company must then file the Tribunal’s order with the Registrar within thirty days, and the reduction takes effect upon registration.

Accounting and Legal Effect

The effect of reduction depends on the method used. If the company extinguishes or reduces unpaid liability, shareholders’ obligations are decreased. If it cancels paid-up capital lost or unrepresented by assets, the balance sheet is adjusted to reflect the true value of net assets. If the company pays off excess capital, it returns funds to shareholders. In all cases, the share capital figure in the memorandum and balance sheet is altered accordingly.

Reduction of capital does not necessarily involve repayment; it can simply be an internal adjustment. For example, if a company’s shares of ₹100 each are partly paid to ₹75, it can by resolution reduce the nominal value to ₹75 fully paid, thereby extinguishing unpaid liability. Similarly, if part of the capital is lost through accumulated losses, the company may reduce the nominal value of shares to align with actual asset value.

Judicial Supervision and Case Law

Judicial authorities have consistently emphasised that reduction of capital must be conducted bona fide, with due regard to the interests of creditors and minority shareholders. In British and American Trustee and Finance Corporation v. Couper (1894 AC 399), the House of Lords held that reduction of capital is permissible provided it is fair and equitable and does not unfairly prejudice creditors. Indian courts have adopted the same principle. In Re Panruti Industrial Co. Pvt. Ltd. (1975 45 Comp Cas 581 Mad), the Madras High Court observed that the primary concern in sanctioning reduction is the protection of creditors.

In Re CKP Co-operative Bank Ltd. (2019 213 Comp Cas 299 Bom), the Bombay High Court, applying Section 66, reiterated that the Tribunal’s role is to ensure that the company’s solvency is not impaired and that the reduction is not contrary to public interest. The court noted that once these conditions are met, the commercial wisdom of shareholders should generally not be interfered with.

In Re Reckitt Benckiser (India) Ltd. (2005 125 Comp Cas 184 All), the court confirmed that reduction of capital by cancelling paid-up share capital unrepresented by assets was permissible and did not amount to extinguishing liabilities towards creditors.

Reduction versus Buy-Back and Amalgamation

Reduction of capital must be distinguished from buy-back of shares and from capital reorganisation in amalgamations. While buy-back under Section 68 involves repurchase of shares by the company out of its free reserves or securities premium, reduction of capital involves alteration of the company’s capital base itself. Buy-back is a self-executing mechanism, whereas reduction requires judicial confirmation. Similarly, in amalgamation, share capital may be restructured under Section 230 to 232, but that process is court-approved as part of a scheme of arrangement.

Protection of Creditors and Public Policy

The underlying public policy in regulating reduction of share capital is the protection of creditors. Capital is treated as a security fund for creditors, and its reduction without adequate safeguards may impair their ability to recover debts. Therefore, the Tribunal, before confirming a reduction, must ensure that creditors have either consented, been paid, or their claims have been adequately secured. Any reduction that would prejudice creditors is prohibited.

The requirement of Tribunal confirmation also serves to ensure transparency and public confidence. It acts as a judicial oversight mechanism to prevent misuse of the reduction process for ulterior motives such as oppression of minority shareholders, tax avoidance, or manipulation of shareholding structure.

Procedure after Tribunal Confirmation

Once the Tribunal passes the order confirming the reduction, the company must deliver the order and a minute approved by the Tribunal showing the amount of the reduced share capital to the Registrar. The Registrar registers the order and the minute, and issues a certificate of registration, which serves as conclusive evidence of compliance. The memorandum and articles of the company are then altered accordingly.

Following the reduction, the company must update its books of account and issue fresh share certificates reflecting the reduced capital. The company must also disclose the reduction in its next financial statements, along with the rationale and its effect on shareholders’ funds.

Penal Consequences of Default

Failure to comply with the requirements of Section 66 attracts penalties. If the company conceals creditor information, fails to obtain confirmation, or contravenes conditions imposed by the Tribunal, it and its officers are liable to punishment under Section 67 of the Act. Further, any shareholder or creditor aggrieved by an unlawful reduction may apply for rectification or damages.

Contemporary Judicial Perspective

Recent decisions of the National Company Law Tribunal have shown a pragmatic approach towards corporate restructuring. The Tribunal has emphasised that as long as the company complies with statutory safeguards and demonstrates that creditors’ and public interests are protected, the Tribunal should not substitute its commercial judgment for that of shareholders. This approach reflects deference to business discretion while maintaining legal oversight.

Part III – Comparative and Analytical Discussion

The issue of bonus shares and reduction of share capital represent two sides of capital reorganisation — expansion and contraction. In both cases, the company alters its balance between paid-up capital and reserves to reflect its economic condition. Both actions require authorisation in the company’s articles, shareholder approval by special or ordinary resolution, and compliance with statutory conditions.

While bonus issues are primarily an internal capitalisation of profits and serve as a reward mechanism, reduction of capital is an external contraction of capital aimed at restructuring. Bonus issues enhance shareholder confidence, whereas reduction of capital, though sometimes viewed negatively, may strengthen the company’s financial statements by eliminating fictitious assets or over-stated capital.

A key legal distinction lies in their procedural control: bonus issues are internal company matters requiring only shareholder approval and, for listed entities, regulatory compliance; reduction of capital requires judicial confirmation because of its potential impact on creditors and the public.

From a jurisprudential perspective, both mechanisms underscore the doctrine of maintenance of capital — a cornerstone of company law. While companies enjoy flexibility in structuring their capital, they must do so within the boundaries of fairness, creditor protection, and transparency. Courts and regulators act as guardians of these principles, ensuring that changes in capital structure are not used as instruments of fraud or oppression.

Conclusion

The issue of bonus shares and reduction of share capital are vital corporate finance tools that enable companies to manage their equity base in response to changing business realities. The Companies Act, 2013 provides a balanced framework that combines corporate flexibility with protection of investors and creditors.

The issue of bonus shares, governed by Section 63, allows companies to convert accumulated reserves into share capital, rewarding shareholders and aligning paid-up capital with the company’s real worth. The safeguards built into the statute — such as prohibiting use of revaluation reserves, requiring prior shareholder approval, and ensuring no default on debts — maintain the integrity of the process.

Conversely, reduction of share capital under Section 66 allows a company to correct over-capitalisation, eliminate losses, or return excess funds to shareholders, but only with Tribunal confirmation to ensure creditor protection. The judicial role under this section preserves the doctrine of capital maintenance and ensures fairness, solvency, and public confidence in corporate governance.

Both mechanisms reflect the dynamic character of modern corporate law, which must reconcile flexibility in business operations with the imperatives of accountability and investor protection. For legal practitioners, company secretaries, and corporate executives, understanding the conceptual distinctions, procedural steps, and judicial principles governing these actions is indispensable. The recent shift from High Court to NCLT supervision has made the process more efficient while retaining judicial oversight.

Ultimately, whether a company increases its share capital through bonus issues or decreases it through reduction, these processes must be undertaken in the spirit of fairness, transparency, and compliance with statutory obligations. They symbolise the equilibrium that corporate law seeks to maintain between business freedom and the safeguarding of public and stakeholder interests.

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