Preference shares are shares that carry a fixed dividend and a priority on repayment. Unlike equity shares, preference shares are usually redeemable — the company must buy them back after a fixed period. Section 55 of the Companies Act, 2013 governs the redemption.
The 20-year rule
Preference shares must be redeemed within 20 years from the date of issue. A company cannot issue perpetual preference shares, except in limited cases such as infrastructure companies with a notified exemption. The 20-year limit protects investors from an indefinite lock-in.
Where the money can come from
A company can redeem preference shares from two sources:
- Out of profits that are available for dividend
- Out of the proceeds of a fresh issue of shares made for the purpose of redemption
A company cannot redeem preference shares out of its capital. If the redemption is funded from profits, the company must transfer an amount equal to the face value of the redeemed shares to the Capital Redemption Reserve (CRR).
The Capital Redemption Reserve
The CRR is a reserve created to protect creditors. When preference shares are redeemed out of profits, the company's capital reduces, and the CRR is created to maintain the capital base. The CRR can be used only for issuing fully paid bonus shares, and it cannot be distributed as dividend.
The redemption premium
If the preference shares were issued at a premium and are redeemed at a premium, the premium on redemption must be provided for. The premium can be paid out of the securities premium account, the profits of the company or the proceeds of a fresh issue. The accounting treatment should be decided before the redemption.
The practical points
The company should check the terms of the preference share issue before redemption. It should decide the funding source — profits or fresh issue — and create the CRR where required. It should pass the board resolution, update the register of members and file the necessary forms with the ROC. The redemption should be completed within the 20-year limit.
Call to Action: We advise companies on preference share redemption, CRR creation and funding options. For a redemption review, contact office@anujdesaiassociates.com, Ph No. 9619456656, Website https://anujdesaiassociates.com, LinkedIn linkedin.com/in/ca-anuj-desai-122547230.