Capital-Redemption-Reserve

Companies Act – Capital Redemption Reserve

Companies Act – Capital Redemption Reserve

Capital Redemption Reserve (CRR) is a requirement under the Companies Act which applies to buy-back schemes and redemptions of preference capital. The requirement should be followed by companies which are redeeming preference capital through any of the three specified modes. The specified modes include redemption from distributable profit and redemption through a fresh issue of capital. The requirement for the CRR also applies to companies which are making an offer for repurchasing capital. The repurchase may be made from the public under a scheme of buy-back. The provisions relating to the CRR are available in Section 69 of the Act.

When a company engages in redemption or buy-back of capital, the capital base is reduced. To compensate for the reduction, the Companies Act provides that a portion of the available reserves should be separately allocated. The allocated portion should be transferred to the CRR. The purpose of the CRR is to ensure that companies maintain the capital base intact in the event of a capital diminution. A capital diminution refers to a depletion in the paid-up capital of a company. It can be caused when a company redeems preference capital or opts to undertake a buy-back scheme.

The requirements of the Companies Act relating to the CRR should be applied in the same manner irrespective of whether the company is repurchasing or redeeming its securities. The intention of the requirement to transfer distributable profit to the CRR is to benefit the lenders. When the capital base of the company is reduced, the lenders may have apprehensions about the safety of the advances made. To provide security to the lenders, the Companies Act requires companies to maintain the required level of CRR. Thus, by introducing funds into the CRR, the capital base of the company is retained intact.

Redemption of Preference Capital

  • All limited liability companies are allowed to raise preference capital. However, a company can raise preference capital exclusively when the Articles provide permission. The maximum validity period of preference capital is twenty years. As per the Companies Act, the issue of irredeemable preference capital is prohibited.
  • A company may be facing an ineffective liquidity position. Hence the company may not be in a position to redeem the preference capital or pay a dividend. In such cases, the company is allowed to make redemption by carrying out a further issue of preference capital. The liability corresponding to the payment of dividend can also be settled by making a further issue of preference capital. However, approval from at least seventy-five per cent of the shareholders is necessary. The approval should be given by passing a resolution in a general body meeting of the company.
  • Redemption refers to the action of a company which involves repaying the capital. Redemption is carried out only in the case of preference capital. Also, the redemption of partly-paid preference capital is not allowed. A company can redeem its preference capital from the profits available for distribution as dividend. Alternatively, the proceeds of a fresh issue of capital may be used.
  • A company may intend to redeem its preference capital from distributable profits. In such cases, an amount which is equal to the nominal value of the redeemed capital should be transferred. The transfer should be made to the CRR. For making the transfer, the general reserve account should be debited. Also, the CRR account should be credited for the same amount. At the time of making the redemption, the company should also follow the provisions which relate to capital reduction.
  • A company may redeem preference shares by paying a premium. In such instances, the premium should be met by using a portion of the company’s profits which is available for dividend distribution. Alternatively, for this purpose, the balance available in the company’s securities premium account can also be used.

Modes of Redemption

  • Redemption can be performed by using the profits which are available to the members of the company as a dividend. In such cases, the CRR should be created. The amount in the CRR should be equal to the nominal value of the preference capital redeemed. The nominal value is known as the threshold limit. An incremental transfer to the CRR should be made exclusively when the balance in the CRR account falls below the threshold limit.
  • Alternatively, the company may carry out redemption by making a fresh issue of capital. In such circumstances, relaxation will be given for the mandatory requirement to maintain a CRR. The relaxation will be given exclusively if the amount of fresh issue of capital is the same as the redemption amount. There may be a difference between the fresh capital issued and the amount of redemption made. In such circumstances, the company should create CRR to the extent of the difference. In place of the redeemed preference capital, the company is allowed to raise equity or preference capital.
  • The redemption can be made partly out of the distributable profits and partly out of the proceeds of a new issue. In such cases, the requirement to create a CRR will apply exclusively to the portion of the capital, which is handled through distributable profits.

Application of CRR

  • The balance in the CRR is allowed to be used exclusively for issuing fully-paid bonus shares to the members of the company. The CRR is a statutory reserve. Hence, it should not be given the same treatment as a free reserve. A free reserve is one which is eligible for distribution as dividend. The term distributable profit refers only to free reserves. The following items should be excluded before arriving at the quantum of free reserves:
    • Unrealised gains
    • Notional gains arising from the revaluation of assets or diminution of liabilities
    • Self-generated intangible assets which are recognised in the books
    • Change in the carrying amount of an asset or liability
  • There may be undistributed profits standing to the credit of the books of accounts of the company. Such profits are not eligible to automatically be categorised into CRR. The accounting staff of the company should create an entry for the categorisation. The entry should specify that the reserve is appropriated towards the capital purpose. After passing the entry, the earmarked portion of the profits becomes inaccessible to the members for dividend purposes. The purpose of the entry is to set apart a portion of the profit for a specific purpose. The entry must be approved by the accounts committee and the audit committee of the company.
  • Reserves are classified based on the source from which the company has earned the corresponding revenue. A company may engage in trading activities and consequently generate revenue. The associated earnings should be classified as revenue and carried under the heading of revenue reserve. Alternatively, a company may carry out transactions which are of a capital nature. Revaluation of assets, amalgamation-related transactions and other similar entries fall under this category. In such cases, the associated earnings are classified as capital receipt and carried under the heading of capital reserve. A company may suffer capital losses. The purpose of adjusting the losses is realised by using the funds from the capital reserve. The CRR should be categorised both as a capital reserve and a statutory reserve.

To know about the procedure for dematerialisation in private companies, click here.

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