Bonus Shares Under Section 63: The Rs 1 Lakh Trap Behind a “Free” Share Issue (2026 Guide)

A profitable Bengaluru software company decided to reward its shareholders with a 2:1 bonus issue in March. No cash left the bank. The board was pleased. Six months later the Registrar issued an adjudication notice: the return of allotment in Form PAS-3 had been filed 74 days late. The penalty worked out to Rs 74,000 on the company and the same again on every officer in default, and the whole thing was capped only because Section 39(5) stops the meter at Rs 1 lakh per person. A "free" share issue had turned into a six-figure bill.

The bonus issue of shares looks like the simplest corporate action on the books. You capitalise reserves, you hand existing shareholders more shares in proportion to what they already hold, and nobody pays anything. That simplicity is exactly why it goes wrong. Founders treat it as a formality, skip the Section 63 conditions, fund it from the wrong reserve, or miss a filing window, and the mistake surfaces at the worst possible moment: during a funding round, a due diligence exercise, or an IPO.

What a bonus issue actually is, and why it is not free

A bonus issue is the capitalisation of a company's accumulated reserves into share capital. Instead of paying reserves out as a dividend, the company converts them into fully paid-up shares and allots those shares to existing members in a fixed ratio, say one new share for every two held. The shareholder's economic stake does not change on the day of the issue. The pie is cut into more slices, and each slice is thinner.

The word "free" is where founders get careless. The shares are free to the shareholder, but the transaction is a regulated issue of securities. It is governed by Section 63 of the Companies Act, 2013, read with Rule 14 of the Companies (Share Capital and Debentures) Rules, 2014, and for listed companies by Regulations 293 to 295 of the SEBI (ICDR) Regulations, 2018. Every one of those provisions carries a condition, a form, or a deadline. Miss one and the "free" issue starts costing money.

The Section 63 conditions you must satisfy first

Section 63(2) sets out pre-conditions. These are not paperwork you complete afterwards. If any one of them is not met on the date the board recommends the bonus, the issue is defective from the start.

1. Authorised by the Articles. Your Articles of Association must permit a bonus issue. If they are silent, alter the Articles by special resolution before you proceed, which brings its own MGT-14 filing.
2. Recommended by the board, authorised in general meeting. The board recommends the ratio and the source of funds; the members then authorise it. Rule 14 requires an ordinary resolution as a minimum, though many Articles insist on a special resolution.
3. No default on deposits or debt securities. The company must not be in default on the payment of interest or principal on fixed deposits or debt securities it has issued.
4. No default on statutory dues to employees. Provident fund contributions, gratuity and bonus payable to employees must be up to date.
5. Partly paid-up shares made fully paid-up. You cannot run a bonus issue while any existing shares remain partly paid. Make them fully paid first.

Section 63(1) adds a hard restriction on the source of funds, and Section 63(3) adds one more line that trips people up: bonus shares cannot be issued in lieu of a dividend. A company that is short on cash cannot dress up a skipped dividend as a bonus.

The reserve you fund it from decides whether it is valid

This is the single most common technical error, and for a company heading towards a fundraise or a listing it is the most expensive. Section 63(1) allows a bonus only out of three sources, and specifically bars a fourth.

A bonus funded from a revaluation reserve is not just a Companies Act problem. For an IPO-bound company it collides with the SEBI ICDR framework, which is where the real damage happens. More on that below.

The process, step by step, with the two clocks that matter

Once the conditions are met, the mechanics are a sequence of board and member actions followed by two filings. The two 30-day clocks are the part founders forget.

Two Rule 14 points are worth pinning to the wall. First, a bonus once recommended by the board and announced cannot be withdrawn. Second, the issue must be completed within six months of the board's approval. There is no room to announce a bonus for sentiment and quietly drop it later.

What non-compliance actually costs

The penalties are specific, they run per day, and they apply to the company and to every officer in default at the same time. Here is the exposure on the filings a bonus issue generates.

Stack these and a single sloppy bonus issue can generate a liability well past Rs 3 lakh across the company and its directors before anyone notices. None of it buys the company anything. It is pure leakage from a transaction that was meant to be a reward.

What you must do now: a working checklist

1. Read your Articles. Confirm they authorise a bonus issue. If not, plan the alteration first, because that adds a special resolution, an MGT-14 and time.
2. Confirm the reserve. Verify in the audited accounts that you have enough free reserves, securities premium or CRR to cover the full paid-up value of the new shares. Rule out revaluation reserves entirely.
3. Clear every default. Check fixed deposit and debt servicing, and check PF, gratuity and employee bonus dues. A live default sinks the whole issue.
4. Fix partly paid shares. Make any partly paid-up shares fully paid before the board meeting.
5. Check authorised capital headroom. If the bonus takes issued capital past authorised capital, increase authorised capital in the same general meeting and file SH-7 within 30 days with the correct stamp duty.
6. Hold two board meetings. One to recommend and call the general meeting, one to allot after member approval. Keep the SS-1 and SS-2 records clean.
7. Diarise both 30-day clocks. MGT-14 from the date of any special resolution; PAS-3 from the date of allotment. Set reminders at day 20, not day 29.
8. Issue certificates or demat credit within 2 months and update the register of members and the beneficial position with the depository.
9. Keep the six-month window in view. Complete the issue within six months of the board's recommendation, and remember you cannot reverse it once announced.

The deeper implication: the pre-IPO bonus trap

For a company on the road to listing, the bonus issue stops being a housekeeping item and becomes a governance decision that a merchant banker will scrutinise line by line. Bonus issues are near-universal in the run-up to an IPO, because they let founders expand a small, tightly held capital base into a market-ready share count without raising fresh money. One company issued a 500:1 bonus in November 2025 that created roughly 99.8% of its pre-IPO equity. That scale is normal in this context, and it is exactly why the source of the bonus matters so much.

Under the SEBI (ICDR) Regulations, shares arising from a bonus issue out of revaluation reserves or unrealised profits are excluded from the computation of minimum promoters' contribution. In plain terms, a bonus funded from the wrong reserve does not count towards the 20% that promoters must lock in. A founder who ran a large bonus off a revaluation reserve two years before the DRHP can discover, mid-diligence, that a chunk of their holding is ineligible for the promoter contribution and the lock-in maths no longer works. Unwinding that close to a filing is painful and sometimes not possible.

According to CS Sapna Malpani, most pre-IPO bonus problems are not born in the IPO year at all. They are born two or three years earlier, in an ordinary board meeting where nobody asked which reserve the bonus was coming from. The fix costs almost nothing at the time and a great deal later. Her forward view for the next few filing cycles is that as more private companies dematerialise and professionalise ahead of the strong Indian listing pipeline, secretarial auditors and merchant bankers will treat historical bonus issues as a standard diligence checkpoint, and the companies that documented the reserve source correctly will clear it in an afternoon.

Listed companies have a tighter timetable of their own. Under SEBI ICDR Regulation 295, a bonus must be implemented within 15 days of board approval where no shareholder approval is required, or within two months where a special resolution is needed, and once announced it cannot be withdrawn. The outcome of the general meeting must reach the stock exchanges within the LODR disclosure window, and the record date has to be intimated in advance.

Bonus issue versus the alternatives

Founders often confuse the bonus issue with the other ways of putting shares into hands, and the confusion leads to the wrong resolution and the wrong form. A quick separation helps.

A bonus issue gives free shares to all existing shareholders in proportion, funded by reserves, with no money coming in. A rights issue offers existing shareholders the chance to buy more shares, usually at a discount, and does bring in money. A private placement or preferential allotment issues shares to selected investors for cash or consideration, and carries the Section 42 and Section 62(1)(c) machinery, valuation reports and tighter timelines. The tax treatment differs too. Bonus shares carry a nil cost of acquisition under Section 55(2) of the Income-tax Act, the holding period runs from the date the bonus shares are allotted, and the bonus stripping rule in Section 94(8) sits in the background for anyone trying to book an artificial loss. If your goal is to raise capital, a bonus is the wrong tool. If your goal is to reward holders or expand the share base from reserves you already have, it is the right one, provided you run it correctly. For a fuller comparison, see our guide on rights issue versus private placement versus preferential allotment, and on keeping the equity structure clean, cap table mistakes that block a Series A.

Sources and references

• Section 63, Companies Act, 2013 — India Code / IndianKanoon (indiankanoon.org/doc/65117953)
• SEBI (ICDR) Regulations, 2018, Chapter XI (Regulations 293 to 295) and FAQs on Issue of Capital (sebi.gov.in ICDR FAQs)
• SEBI guidelines for bonus issues (sebi.gov.in)
• Rule 14, Companies (Share Capital and Debentures) Rules, 2014, Ministry of Corporate Affairs
• SEBI (ICDR) Amendments, 2025, pre-IPO disclosure changes (Cyril Amarchand Mangaldas client alert, March 2025)
• Section 55(2) and Section 94(8), Income-tax Act, 1961 (cost of acquisition and bonus stripping)

Frequently asked questions

What is a bonus issue of shares under Section 63?

A bonus issue is the capitalisation of a company's reserves into fully paid-up shares, which are then allotted to existing shareholders in a fixed ratio at no cost to them. It is governed by Section 63 of the Companies Act, 2013 and Rule 14 of the Companies (Share Capital and Debentures) Rules, 2014. The shareholder's proportional stake stays the same; the company simply converts reserves it already holds into share capital, so no fresh money comes into the business.

Which reserves can be used for a bonus issue?

Only three sources are permitted under Section 63(1): free reserves, the securities premium account and the capital redemption reserve. A bonus issue cannot be funded from a revaluation reserve or from any unrealised or notional gain, because the proviso to Section 63(1) specifically excludes reserves created by the revaluation of assets. Using the wrong reserve makes the issue defective and, for an IPO-bound company, can disqualify those shares from the minimum promoters' contribution under the SEBI ICDR Regulations.

What is the penalty for late filing of PAS-3 on a bonus issue?

Form PAS-3, the return of allotment, must be filed within 30 days of the allotment of bonus shares. Under Section 39(5), a default attracts a penalty of Rs 1,000 for each day the default continues, subject to a maximum of Rs 1,00,000, and this applies both to the company and to every officer in default. A delay of two to three months therefore reaches the cap quickly, which is why the PAS-3 clock is the one most worth diarising.

Do I need to pass a special resolution for a bonus issue?

Rule 14 requires at least an ordinary resolution in the general meeting, on the board's recommendation. Many companies' Articles, however, require a special resolution, and a special resolution is also needed if you have to alter the Articles to authorise the bonus or increase the authorised share capital. Wherever a special resolution is passed, Form MGT-14 must be filed within 30 days under Section 117, with exposure of up to Rs 2 lakh on the company for a default.

Can a company issue bonus shares instead of a dividend?

No. Section 63(3) expressly bars a company from issuing bonus shares in lieu of a dividend. A company that is short of cash cannot substitute a bonus issue for a declared dividend. A bonus is a capitalisation of reserves into shares, not a distribution of profit, and the two cannot be swapped.

Why do bonus issues matter before an IPO?

Bonus issues are a standard way to expand a closely held capital base into a market-ready share count before listing, often at large ratios. The risk is that a bonus funded from a revaluation reserve or unrealised profit is excluded from the minimum promoters' contribution under the SEBI ICDR Regulations, which can undo the promoter lock-in calculation during due diligence. Because the problem usually originates two or three years before the draft offer document, the source of every historical bonus should be documented and checked early.

Are bonus shares taxed when received?

There is no tax on the shareholder at the moment bonus shares are received. The tax question arises on a later sale. Under Section 55(2) of the Income-tax Act, the cost of acquisition of bonus shares is taken as nil, and the holding period is counted from the date the bonus shares are allotted rather than from the date the original shares were bought. The bonus stripping provision in Section 94(8) also applies where bonus units or shares are used to book an artificial short-term loss.