Sensex Devta

BONUS DEBENTURE

A new financial instrument

Introduction- We usually come across many financial instruments like Debentures and Bonus shares. Bonus debenture is an instrument very less talked about and used.Bonus debentures are those notes issued by corporates out of their general cash reserves to their shareholders for free. These instruments has a face value,an interest rate and maturity period.Company redeems bonus debenture when the maturity period becomes due.The reserves that the company distributes belong to the share holders.Company could have done it in the form of cash dividend instead of issuing bonus debentures.

Why Bonus Debenture?- A very lucrative proposition for the shareholders is that , the shareholders get interest in all the year till maturity. Company also benefits by getting advantage of tax as the interest on debenture is tax deductible. Bonus debentures do not dilute the share value like bonus share and the company can take the advantge of leverage.

Tax benefits- For tax purpose allotment of bonus debenture would be treated as dividend. Since bonus debentures are issued out of the post tax profits accumulated by the company, the company does not get any deduction in the income statement for the value of debenture that have been issued. Company pays a dividend distribution tax on the amount of bonus debenture issued. In subsequent years, when the debentures are either sold or redeemed, the sale price or redemption value received by debenture holder will not be taxable to the extent of the capital value of debentures already taxed as dividend in the year of issue of bonus debenture.

Journey of Bonus debenture in India- Origin of bonus debenture in India starts in 2001. HUL (Then HLL) came out with the proposal to issue this innovative instrument. But before the scheme could be implemented, the Government changed taxation laws, and as per the Finance At 2002, dividend became taxable in the hands of shareholders. HLL therefore revised its Bonus debenture scheme to the Scheme self-financing such that shareholders, even at the highest tax bracket, do not have to pay tax on these bonus debentures out of their own pocket.

This revised bonus debenture scheme was approved by shareholders at the Bombay High Court-convened meeting on 9^th, August 2002. As per the scheme in addtion to the bonus debentures of Rs. 6 each per share, HLL also decided to pay a Special Dividend of Rs. 2.76 per share as a part of the scheme.

Similarly, there have been a few more companies that have issued bonus debenture to its existing shareholders. AstraZeneca Pharma India Lt. and Britannia Industries Ltd. Are amongst them.

Bottelnecs for Bonus Debenture.- As we can see after 2001 there are only few companies who issued these instruments. Apart from a number of advanteges bonus debentures have some drawbacks. We can understand these with comparision of some other instruments with this-

1. Bonus share Vs Bonus Debenture- By issuing bonus shares, the equity of the company does not get altered, but when tha bonus debentures are issued, it result in decrease in equity and a corresponding increase in debt. This results in high leverage and thus increases the risk preception of the company.

2.Dividend Vs Bonus debenture- Dividend involves innediate cash receipt for the shareholders but bonus debentures does not involve immediate cash fully, some part of interest may be cash receipt. Secondly the scheme of the arrangement of issuing bonus debentures is prepared under section 391 to saction 394 of the companies act, so it involves a lot of legal proceedings like approval of the high court etc.

Market reaction- Stock market,s reaction to the declaration of bonus debentures has also been studied and in majority of cases a declining trend was found after the declaration of this financial instrument. This maybe because of less popularity of this instrument and some drawbacks as discussed above.