Can bonus shares be issued by capitalising revaluation reserves?

Position under the Companies Act,1956-Unlisted company could issue bonus shares by capitalising revaluation reserve in view of SC's ruling in Bhagwati Developers case
The proviso to sub-section (3) of section 205 of the 1956 Act permitted capitalization of profits or reserve of a company for the purpose of issuing fully paid up bonus shares or paying up any amount for the time being unpaid on any shares held by the members of the company. Thus, the 1956 Act specifically permitted utilization of reserve arising from revaluation of assets for purpose of issuing fully paid up bonus shares. In view of the aforesaid proviso, a company can issue bonus shares by capitalization of revaluation reserve if the Articles of Association of the company so permits.-Bhagwati Developers v. Peerless General Finance & Investment Co. [2005] 62 SCL 574 (SC). In the above case, Supreme Court was concerned with an
unlisted company. In case of listed companies, the SEBI (ICDR) Regulations, 2009 prohibits issue of bonus shares by capitalization of revaluation reserves. The SEBI (ICDR) Regulations is not applicable
to unlisted companies. Thus, under the 1956 Act, an unlisted company could use revaluation reserve for issuing bonus shares.

Section 63 of the Companies Act,2013 bars all companies from capitalising revaluation reserve to issue bonus shares
In order to overcome Supreme Court’s decision in Bhagwati Developers (supra), proviso to section 63(1) of the Companies Act,2013 provides that no issue of bonus shares shall be made by capitalizing reserves created by the revaluation of assets. This bar on issuing bonus shares out of revaluation reserves applies to all companies whether listed or unlisted.

The provisions of section 63 have been enforced with effect from 01-04-2014. Therefore, with effect from 01-04-2014, no company whether listed or unlisted can issue bonus shares by capitalising revaluation reserves

Duty of auditor where bonus shares issued by capitalising revaluation reserve

Apart from proviso to section 63(1) of the 2013 Act forbidding issue of bonus shares by capitalising revaluation reserves, ICAI's Guidance Note on Availability of Revaluation  Reserve for Issue of Bonus Shares also recommends against the same. According to the Guidance Note, revaluation reserve does not represent a realized gain. It is created as a result of a book adjustment only. It does not result from an arm’s length transaction. Since revaluation reserve does not represent a realized gain, it cannot be used for issue of bonus shares/to increase amount paid-up on equity shares. If company uses revaluation reserve for issue of bonus shares/to increase amount paid-up on equity shares , auditor will have to qualify its report. 

The statutory auditor should qualify his audit report if company issues bonus shares on or after 01-04-2014 capitalising its revaluation reserves in contravention of section 63 of the 2013 Act. An illustrative qualification is as under:

Basis for qualified opinionThe company has issued bonus shares for Rs…………(……equity shares of Rs……….each)by capitalizing its revaluation reserve. Accordingly, the Paid-Up Equity Share Capital of the company stands increased by Rs…….. and the revaluation reserve stands reduced by that amount. The issue of bonus shares as aforesaid is contrary to provisions of section 63 of the Companies Act,2013 and the recommendations of the Institute of Chartered Accountants of India. Had the company not issued bonus shares by capitalising its revaluation reserves, its paid-up equity share capital would have been lower by Rs...... and its revaluation reserves would have been higher by Rs......OpinionIn our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:
(a)in the case of the Balance Sheet, of the state of affairs of the Company as at March 31, 20XX;
(b)in the case of the Profit and Loss Account, of the profit/ loss for the year ended on that date;  and
(c)in the case of the Cash Flow Statement, of the cash flows for the year ended on that date.

The above is in accordance with Standard of Auditing SA 705 Modifications to the Opinion in the Independent Auditor’s Report and ICAI's Guidance Note on Availability of Revaluation  Reserve for Issue of Bonus Shares