Redemption of Preference Shares Essay Example

such as redeemable preference shares that can be repaid under Section 80 of the Companies Act, 1956.

ii) Irredeemable Preference Shares are preference shares without a redemption agreement.

Convertible Preference Shares allow the holder to convert them into equity shares according to the terms and conditions of the issue.

Non-convertible Preference Shares are shares that lack the ability to be transformed into equity shares. Unless specified otherwise, all Preference shares are considered non-convertible.

v) Participating Preference Shares: These shares allow the holder to receive additional dividends, on top of their regular dividends. This is possible if there are surplus profits remaining after the equity shareholders have received their fixed dividend at the Annual General Meeting.

vi) Non-participating Preference Shares: These shares do not have the right to receive additional dividend and only receive a fixed rate of dividend, unless stated otherwise.

vii) Cumulative Preference Shares: Cumulative preference shares have the privilege of receiving a fixed dividend amount. Shareholders of these shares will receive dividends from future profits if the current year's profit is insufficient. Therefore, the dividend on these shares will accumulate until the final payment.

The Non-cumulative Preference Share does not accumulate dividends for shareholders. If there is insufficient profit, this type of preference shareholder will not receive any dividend, and any unpaid dividends will be forfeited.

The redemption of preference shares under section 80 of the Companies Act, 1956 requires a company to meet certain conditions. These conditions are:

1. There must be a provision in the company's Articles of Association that allows for the redemption of preference shares.
2. The redeemable preference shares must be fully paid up. If there are any partly paid shares, they must be converted into fully paid
   

shares before redemption.

iv) Shares redeemed at a premium should be provided out of securities premium, profit and loss account, or general reserve account.
v) Proceeds from fresh issue of debentures cannot be used for redemption.
vi) The amount of capital reserve cannot be used for redeeming preference shares.
vii) If shares are redeemed from undistributed profit, the nominal value of the redeemed share capital should be transferred to the Capital Redemption Reserve Account, also known as capitalization profit.

In order to redeem its redeemable preference shares, a company must adhere to the aforementioned conditions. The subsequent section will address the Capital Redemption Reserve account.

If the preference shares are redeemed using accumulated profit, an equivalent amount must be transferred to the Capital Redemption Reserve Account. If new shares are issued for redemption, the transferred amount will be the difference between the nominal value of the redeemed shares and the nominal value of the issued shares (i.e. CRR = Nominal value of redeemed shares - Nominal value of issued shares). The Capital Redemption Reserve Account can be utilized for issuing fully paid bonus shares.

The necessity of establishing a capital redemption reserve account is twofold. Firstly, it serves to safeguard the rights of creditors, while secondly, it ensures the maintenance of working capital. The redemption of preference shares entails reimbursing the invested capital prior to fulfilling the obligations owed to the company's creditors. This may impact the interests of said creditors. Furthermore, the withdrawal of funds due to the redemption process will deplete the company's working

capital. Creating a capital redemption reserve account allows for the capital amount to be preserved and accounted for. Consequently, this amount becomes unavailable for dividend distributions, thus protecting the interests of creditors and simultaneously replenishing the working capital.

If the conditions mentioned in the previous section are followed, it becomes evident that when preference shares are redeemed using accumulated profit, an equal amount must be transferred to the Capital Redemption Reserve Account. In cases where the company issues new shares for redemption, the transferred amount will be the difference between the nominal value of the redeemed shares and the nominal value of the newly issued shares (i.e. CRR = Nominal value of redeemed shares – Nominal value of issued shares). The Capital Redemption Reserve Account can then be utilized for issuing bonus shares that are fully paid.

The creation of a capital redemption reserve account has two primary functions. First, it safeguards the interests of creditors by giving them priority for payment before any capital is redeemed, especially when redeeming preference shares. Second, it helps maintain the company's working capital by preventing depletion of available funds through cash outflows involved in capital redemption. By establishing a capital redemption reserve account, this amount can be capitalized and not used for dividend distribution. This safeguards creditors' interests and replenishes working capital.

If preference shares are redeemed using accumulated profit, the same amount must be transferred to the Capital Redemption Reserve Account. When new shares are issued for redemption, the transferred amount is determined by subtracting the nominal value of the issued shares from the nominal value of the redeemed shares (CRR = Nominal value of shares redeemed – Nominal value

of shares issued). The Capital Redemption Reserve Account can subsequently be utilized for issuing fully paid bonus shares.

The purpose of establishing a capital redemption reserve account is twofold. Firstly, it serves to safeguard the interests of creditors by ensuring that they are prioritized for payment before any capital is redeemed. This is particularly important when dealing with preference shares that could potentially impact the creditors' interests. Secondly, the creation of this reserve account helps maintain the company's working capital. When capital is redeemed, it involves cash outflow which can deplete the company's working capital. However, by converting this amount into capital and establishing a reserve account, it guarantees that the funds will not be distributed as dividends. This serves to protect both the creditors' interests and replenish the company's working capital.