Bonus to non-residents by Indian Inc. by way Redeemable preference shares

Innovation gets more innovative when it comes to taxes, finance and law. When the corporate inc. put their minds to save the shareholders money and put it to best possible use and to increase the value. One such innovative product is Redeemable preference shares issued as Bonus shares. Since its Diwali time, there cannot be better subject for discussion than Bonus.

In this article, we have discussed about the issue of Redeemable preference shares as Bonus to non-resident shareholders being registered Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs) deemed as registered Foreign Portfolio investors, registered Foreign Portfolio Investors (FPIs), long term investors registered with SEBI – Sovereign Wealth Funds (SWFs), Multilateral Agencies, Pension/ Insurance/ Endowment Funds, foreign Central Banks and Non-resident Indians  (referred together as “non-resident shareholders”).

A company usually employs two methods to share its divisible profits with its investors: cash dividends and bonus shares. Cash dividends involve immediate payment of cash by the company (involving huge outflows from the company immediately, which could have been retained by the company for business purposes for a little longer) and bonus shares involving issuance of additional shares to the equity investor.

A bonus share is a free share of stock given to current shareholders in a company, based upon the number of shares that the shareholder already owns. Section 63 of Companies Act, 2013 specifies that a company may issue fully paid-up bonus shares to its members, in any manner whatsoever, out of—

  • its free reserves;
  • the securities premium account; or
  • the capital redemption reserve account:

However, no issue of bonus shares can be made by capitalising reserves created by the revaluation of assets and no such share shall be issued in lieu of dividend.

Following conditions needs to be satisfied for issue of bonus shares

  • it is authorised by articles of association of the company;
  • it has, on the recommendation of the Board, been authorised in the general meeting of the company;
  • The company should not have defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;
  • The company should not have defaulted in respect of the payment of statutory dues of the employees, such as, contribution to provident fund, gratuity and bonus;
  • the partly paid-up shares, if any outstanding on the date of allotment, should be made fully paid-up;
  • it should comply with such conditions as may be prescribed under Companies Act,2013.
  • In case of listed companies, it should comply with SEBI (Issue of capital and disclosure requirements) Regulations, 2009.
  • In case bonus share are issued to non resident shareholders it needs to comply with FDI Policy read with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 issued by Reserve Bank of India

A company can have two types of capital i.e. Equity share capital and Preference share capital.

As per Section 43 of Companies Act 2013,

“(ii) ‘‘preference share capital’’, with reference to any company limited by shares, means that part of the issued share capital of the company which carries or would carry a preferential right with respect to—

(a) payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may either be free of or subject to income-tax; and

(b) repayment, in the case of a winding up or repayment of capital, of the amount of the share capital paid-up or deemed to have been paid-up, whether or not, there is a preferential right to the payment of any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company;

Also, capital shall be deemed to be preference capital, notwithstanding that it is entitled to either or both of the following rights, namely: —

(a) that in respect of dividends, in addition to the preferential rights to the amounts specified in sub-clause (a) of clause (ii), it has a right to participate, whether fully or to a limited extent, with capital not entitled to the preferential right aforesaid;

(b) that in respect of capital, in addition to the preferential right to the repayment, on a winding up, of the amounts specified in sub-clause (b) of clause ( ii), it has a right to participate, whether fully or to a limited extent, with capital not entitled to that preferential right in any surplus which may remain after the entire capital has been repaid.The redemption of preference share can happen only out of the profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of such redemption. Shares should be fully paid at the time of redemption. Capital redemption reserve needs to be created where such shares are proposed to be redeemed out of the profits of the company. The capital redemption reserve account may be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares. (Section 55 of the Companies Act, 2013)

There are following types of preference shares.

  • Cumulative: In Cumulative Preference shares all dividends are carried forward until specified, and paid out only at the end of the specified period.
  • Non-cumulative: In case of non- Cumulative Preference shares dividends is paid out of profits for every year. There are no arrears carried over a time period to be paid at the end of the term.
  • Redeemable: Such preference shares can be claimed after a fixed period or after giving due notice. A company limited by shares may, if so authorised by its articles, issue preference shares which are liable to be redeemed within a period not exceeding twenty years from the date of their issue.
  • Irredeemable: Such shares cannot be redeemed during the lifetime of the company, but can only be obtained at the time of winding up of assets. No company limited by shares can issue any preference shares which are irredeemable.
  • Convertible: The shares can be converted into equity shares after a time period, or as per the conditions laid down in the terms.
  • Non-convertible: Non-convertible preference shares cannot be, at any time, converted into equity shares.
  • Participating: Participating shares have the right to participate in any additional profits, after paying the equity shareholders.
  • Non-Participating: Non-participating preference shares do not possess any right to participate in surplus profits or any surplus gained at the time of liquidation of the company.

From Company Act prospective both Equity Share Capital and Preference share capital forms part of Share capital of the company.

For the purpose of Foreign Direct Investment(FDI)[1]quity shares, compulsorily and mandatorily convertible preference shares and compulsorily and mandatorily convertible debentures are treated as a part of share capital. Companies can issue equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily convertible preference shares to non resident shareholders subject to pricing guidelines/valuation norms prescribed under FEMA Regulations to a person resident outside India.

It is to be noted that in case of FDI only fully, compulsorily and mandatorily convertible preference shares are considered to be Equity capital and other types of Preference shares/Debentures i.e. non-convertible, optionally convertible or partially convertible for issue of which funds have been received on or after May 1, 2007 are considered as debt. Accordingly, all norms applicable for ECBs relating to eligible borrowers, recognized lenders, amount and maturity, end-use stipulations, etc. shall apply. Since these instruments would be denominated in rupees, the rupee interest rate will be based on the swap equivalent of London Interbank Offered Rate (LIBOR) plus the spread as permissible for ECBs of corresponding maturity.

Any transaction by a company with a non-resident involving foreign exchange is regulated by Foreign exchange management Act, 1999. The issue of shares (Equity as well as Preference) to a person outside India is governed by Foreign Direct Investment policy 2016 issued by Department of policy and promotion read with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 issued by Reserve Bank of India. The type of instruments that can be issued to person resident outside India, the entities in which investment can be made in India, the manner and mode of investment from outside India all is governed by Foreign Direct Investment policy 2016 read with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000.

Any transaction with non-residents if not allowed by Reserve Bank of India (RBI) in general requires prior approval of RBI. Issue of plain vanilla Bonus shares in the form of Equity shares falls under the general permission of RBI in ususal cases and does not require prior approval of RBI. An Indian company may issue bonus shares to its non-resident shareholders, subject to the following conditions:

(a)   The shares against which bonus shares are issued by the company were acquired or held by the non-resident shareholder in accordance with the Rules/Regulations applicable to such acquisition;

(b)   The bonus shares acquired by the non-resident shareholder shall be subject to the same conditions including restrictions in regard to repatriability as are applicable to the original shares.

Issue of redeemable preference shares as Bonus did not fall under the general approval of RBI. Till now RBI was allowing such an issue on a case to case basis. [2]RBI has been receiving references from Indian companies regarding issue of Redeemable bonus preference shares to non-resident shareholders. With a view to rationalising and simplifying the procedures, RBI Vide A.P. (DIR Series) Circular No.84 dated January 6, 2014 read with Vide A.P. (DIR Series) Circular No.140 dated June 6, 2014 permitted an Indian company to issue[3]redeemable preference shares to non-resident shareholders, including the depositories that act as trustees for the ADR/GDR holders, by way of distribution as bonus subject to satisfaction of conditions.

Conditions to be satisfied by a company for issue of redeemable preference shares as bonus are as follows:

It should be

  1. a) from the general reserve
  2. b) under a Scheme of Arrangement by a Court in India under the provision of the Companies Act
  3. c) under the provisions of the Companies Act, as applicable
  4. d) subject to no-objection from the Income Tax Authorities

The extracts of Circular A.P. (DIR Series) Circular No.140 dated June 6, 2014 are reproduced below

Attention of Authorized Dealer Category-I (AD Category-I) banks is invited to Schedule 5 to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (the Principal Regulations) notified vide Notification No. FEMA.20/2000-RB dated May 3, 2000, as amended from time to time, in terms of which SEBI registered Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs), registered Foreign Portfolio Investors (FPIs) and long term investors registered with SEBI, may purchase, on repatriation basis, Government securities and non-convertible debentures (NCDs) / bonds issued by an Indian company subject to such terms and conditions as mentioned therein and limits as prescribed for the same by RBI and SEBI from time to time. The present limits for investments by FIIs/FPIs, QFIs and long term investors registered with SEBI in corporate debt stands at USD 51 billion.

  1. Attention of AD Category – I banks is also invited to A.P. (DIR Series) Circular No. 84 dated January 6, 2014 in terms of which an Indian company is permitted to issue non-convertible/redeemable preference shares or debentures to non-resident shareholders, including the depositories that act as trustees for the ADR/GDR holders by way of distribution as bonus from its general reserves under a Scheme of Arrangement approved by a Court in India under the provisions of the Companies Act, as applicable, subject to no-objection from the Income Tax Authorities.
  2. On review, it has now been decided to allow registered Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs) deemed as registered Foreign Portfolio investors, registered Foreign Portfolio Investors (FPIs), long term investors registered with SEBI – Sovereign Wealth Funds (SWFs), Multilateral Agencies, Pension/ Insurance/ Endowment Funds, foreign Central Banks to invest on repatriation basis, in non-convertible/redeemable preference shares or debentures issued by an Indian company in terms of A.P. (DIR Series) Circular No. 84 dated January 6, 2014 and listed on recognized stock exchanges in India, within the overall limit of USD 51 billion earmarked for corporate debt. Further, NRIs may also invest, both on repatriation and non-repatriation basis, in non-convertible/redeemable preference shares or debentures as above.There is inherent benefit to company to issue redeemable preference shares as bonus.

There are various ways in which a company can reward its shareholders. Cash dividend, bonus shares and buybacks are the most usual way of paying dividends. The usual ways of paying dividends by the companies are either cash dividends or bonus shares. Cash dividends involve immediate payment of cash by the company (involving huge outflows from the company immediately, which could have been retained by the company for business purposes for a little longer) and bonus shares involving issuance of additional shares to the equity investor. In comparison to this, a bonus redeemable preference share is unique instrument of paying dividend which combines the benefits of cash distribution and bonus shares there by limiting the outgo of huge cash from the company and making it a staggered outflow (at least until redemption).

 Advantages of issuing bonus redeemable preference shares:

a) Redeemable preference shares as bonus ensures availability of funds to meet business and operational needs of the company.

b) This instrument caters to the needs of the investor as well as the company. From a company’s perspective the instrument helps the company to improve its return on equity capital.

c) No impact on reported profits as bonus Redeemable preference shares are issued from the accumulated profits.

d) No immediate cash outflow and the company is able to utilise its excess cash over a period of time, at least until maturity of the instruments.

e) No dilution of Earning Per Share as no expanding the equity capital base.

f) In addition, it is a tax-free receipt of redemption amount. The amount of bonus Redeemable preference shares is not taxable in the hands of holders as the dividend distribution tax is paid by the company.

Diwali is here on 30th Oct. Bonus is synonym of Diwali since time immemorial. So this Diwali  instead of all traditional ways try the new and fancy way of remunerating your shareholders and other investors. Issuance of Redeemable preference share is industrious way in which Bonus can be given to non-resident shareholders.

For any queries kindly be free to write to me at sudha@taxpertpro.com

[1]       In terms of Regulation (2ii) and Regulation 5 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 notified vide Notification No.FEMA.20/2000 -RB dated May 3, 2000, as amended from time to time.

[2]       So far, Reserve Bank has been granting permission for such issuances on a case-to-case basis.

[3]       Vide A.P. (DIR Series) Circular No.84 dated January 6, 2014.

Non-convertible/redeemable preference shares or debentures

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