Buy-Back, Redemption, and Tax

Buy- Back of Shares and Redemption of Preference shares Concepts, accounting treatment, Income tax applications.
By Prof.Augustin Amaladas M.Com., AICWA.,PGDFM.,B.Ed. Prof. Shanthi Augustin M.Com., M.Phil., MBA., B.Ed. www.professoraugustin.com
An old lady, with shabby looks was picking up something from the sea shore but the people, scared of her, did not allow their children to go near her. What was she picking? Why were the people scared of her?
www.professoraugustin.com
Did she pick up Shells or Stones?

Think, before having a look at the next slide. www.professoraugustin.com
She picked up broken pieces of glass Why did she pick up these?
So that these pieces should not harm the children.
Judge not by the looks or colour!!!!!

Meaning of Redemption
Pay back the capital before winding up either by cash or conversion of preference shares into equity shares or pay cash to such share holders.
Buy- Back of sharesMeaning

Take back the equity shares from market or shareholders by paying cash and reduce equity shares available in the share market. It is also known as a stock repurchase. , cash is exchanged for a reduction in the number of shares outstanding. The firm either retires the shares or keeps them as treasury stock, available for re issuance.
Methods of pr-purchase of shares in the USA

1. Open market share purchase: 95% of repurchase is done through this method Daily re-purchase of shares from market is limited The company may not openly announce that it will re-purchase shares from open market
2. Fixed price tender offer

Single purchase price and number of shares sought are mentioned. Person would like to sell to the company should come with offer of the price and number of shares that he offers to the company. If offer from public exceeds than shares sought it may buy on pro rata basis.
Method-3. Dutch auction share repurchases

Range of prices that the company would like to re-purchase are mentioned in the offer. Shareholders can indicate their prices within the rage prescribed. Lowest bidder to highest price bidder are chosen The company has right to cancel the entire offer if a few take holders.
4.Equal access buy-backs
All share holders have given equal opportunity to sell shares to the company.
5.Selective buy-backs
In broad terms, a selective buy-back is one in which identical offers are not made to every shareholder, for example, if offers are made to only some of the shareholders in the company. The scheme must first be approved by all shareholders, or by a special resolution (requiring a 75% majority) of the members in which no vote is cast by selling shareholders or their associates. Selling shareholders may not vote in favour of a special resolution to approve a selective buy-back
Employees stock option repurchase

A company may also buy back shares held by or for employees or salaried directors of the company or a related company. This type of buy-back, referred to as an employee share scheme buy-back, requires an ordinary resolution
on-market buy-backs and minimum holding buy-back

A listed company may also buy back its shares in on-market trading on the stock exchange, following the passing of an ordinary resolution.The stock exchanges rules apply to on-market buy-backs. A listed company may also buy unmarketable parcels of shares from shareholders (called a minimum holding buy-back). This does not require a resolution but the purchased shares must still be cancelled.
Contradicting sections on Buyback of shares in India

Section 77 of the Companies Act does not allow a company to buy its own shares until the winding up of companies. but the subsequent Section 77A permits buyback subject to certain conditions. What is the rationale behind?
Section-77 of the Companies Act

Most of the sections in the Companies Act tries to protect the interest of the outsiders who had lent money in the form of debentures or loans or deposits by restricting company not to pay unless outsiders(loan vendors) are paid fully. Share holders are paid last and has taken maximum risk in the company.
Other sections to protect the interest of outsiders

Section 80 of the Companies Act 1956:Redemption of preference shares:Preference shares can be redeemed out of fresh issue of shares or divisible profits which are normally available for the declaration of dividend or both(Partly by fresh issue of shares and divisible profits) Preference shares can not be redeemed out of fresh issue of Debentures. Why?
Debentures can not be issued to redeem preference shares

Debentures are loan funds from outsiders which will reduce long term solvency of the existing debenture holders of the company.More debt will reduce credit worthiness further. If further shares are issued for redemption of preference shares, one type of own funds go out and another type of own funds come to the company which do not affect credit worthiness of existing debenture holders. Law tries to protect the existing debenture holders.It is the reason Section 77 says own capital can not be returned before making payment to debenture holders.
Rules for redemption of preference shares

Section-80 of the Companies Act: Rule 1: Only fully paid preference shares can be redeemed- Why? When preference shares are issued, it was assured that all money ie to the extent of nominal value of shares will be received by the company.It is a statutory liability of every shareholders to pay fully to the extent of nominal value of shares. The debenture holders are given security not only on the present assets but also future assets that will be realised from partly paid up preference shares.There is a legal obligation on the part of the company to receive the balance of amount from www.professoraugustin.com preference share holders before winding up.
Rule-2
No company can issue any preference shares, shall issue any preference shares which is irredeemable or redeemable beyond 20 years
Rule-3
Preference shares can be redeemed either by fresh issue of shares or out of divisible profits or both.Why? Divisible profits is profits which are freely available for the declaration of dividend to shareholders. Only such profits which are free from all clutches can be used for redemption. How is it done? What is the logic?
What is the mechanism of using revenue profit to CRR account?

Revenue profits which are free for dividend have to be converted into Capital profit.The converted capital profit is known as Capital Redemption Reserve fund.Capital redemption funds(CRR) are used to capitalise proft into fully paid up bonus shares. It means revenue profit becomes shares which will be with the firm for ever and gives effective protection to existing Debenture holders. Journal entry: Profit and loss Account Debit Capital Redemption Account credit It means reduce revenue profit and increase Capital profit. otherwise share holders will ask the company to declare www.professoraugustin.com dividend out of revenue profit.
If there is no revenue profits?

Go for fresh issue of shares. It can be equity or preference.It should not be debentures or loan funds.
If free reserves used For redemption
Steps from Left to right
Revenue profit to Be transferred to CRR account
Redemption of Preference shares
CRR to Fully paid up Bonus shares
Bonus shares to Equity shares

If fresh issue of shares Issued for redemption with CRR Cash received to the extend of Nominal value of shares
CRR
=
Nominal value of Redeemable preference shares Note Premium on issue to be accounted separately
Divisible profits or Profits for redemption
Not divisible/Capital profits
1.Profit and loss Account 2.Reserves 3.Investment fluctuation Reserve 4.Dividend equalisation reserve
1.Security premium 2.Capital Redemption Reserve Account 3.Development rebate reserve 4. Capital profits/reserve 6. Statutory reserve 7. Profits prior to Incorporation
Kept www.professoraugustin.com in the company for ever Can be used for any purpose (Married) (bachelor)
If loss occurred due to sale of Any asset
Set off such capital with Capital reserve
If not enough
Set off against revenue Profit. the balance is DIVISIBLE PROFITS
Premium on redemption
To be set off against existing security premium account and new Security premium on fresh issue of shares
If not enough Reduce such deficit with revenue profits www.professoraugustin.com Then calculate divisible profits.
Amalgamation cost of acquisition of the asset of old company deemed to be the cost of acquisition of the new company(continuing company conversion of bonds or debentures, debenture-stock the cost of acquisition of the asset to the assessee shall be deemed to be that part of the cost of debenture, debenture- stock or deposit certificates in relation to which such asset is acquired by the assessee. If Section 2(1B) is fulfilled it does not attract capital gain as per Income tax Act to share holders. Section 2(1B) states that all assets and liabilities to be transferred to the new company and the new company should be an Indian company. At least 75% of share holders should be the shareholders of the new company(acquiring company)
Demerger
The cost of acquisition of the shares in the resulting company shall be the amount which bears to the cost of acquisition of shares, held by the assessee in the demerged company. No capital gain to the share holder who exchange shares if all conditions are fulfilled.
Buy back of shares( Sec.77A)

Why buy back of shares introduced in India? In late 1996-1999 Indian share market did not move. People hesitate to buy and people were not interested in sell shares as they felt that share market might go up. It is one of the mechanism to make the market to be vibrant in such situation.How?
How?
When shares were issued at premium, the company earned capital profits. If shares are quoted in the market less than nominal value or a little above nominal value the company has a chance to repurchase such shares from market at low price and cancel such shares from the share capital. The remaining share holders value go up because net worth of the firm remain almost the same to the remaining number of shares.
to allow promoters to get a better hold on the company. To wit, if the existing promoters in the saddle are having 20 per cent of the shares and the company announces a 20 per cent buyback in which obviously the promoters will not participate, the bottomline would be their stake now going up to 25 per cent (20 divided by 80). There cannot be a simpler and less expensive way of beefing up one's control in a company. In fact the promoters gain at the expense of the company whose cash is used in bankrolling this exercise.
Buy back of shares

Sec.46A (Income tax act and share holders point of view) Transfer in the year of buy back Capital gain=consideration received minus cost of acquisition(Index if long term)
Buy back and Companies Act

Section-77A(since 1999) Sources for buy back 1. Free reserves(divisible profit) 2. The security premium account 3. Fresh issue of shares(ESOP other securities)
Maximum Buy back

Upto 25% of total paid up share capital and free reserves.
Other conditions
1. Debt equity ratio should not be more than 2:1 after buy back (all secured and unsecured debts are included) 2. All the shares other securities are fully paid up( It is same like redemption of preference shares) 3. Such securities are to be listed on recognised stock exchange 4. If free reserves used the amount used for such purpose to be transferred to Capital Redemption Reserve Account.
Buy-Back from whom?

1. Existing security holders on a proportional basis 2. From open market 3. ESOP 4.If listed securities smaller than such buy back, as prescribed by Stock exchange.
Do your house hold work Without giving excuses.
Thank you
Help your father/mother in cooking


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Buy- Back of Shares and Redemption of Preference shares Concepts, accounting treatment, Income tax applications.

Did she pick up Shells or Stones?

So that these pieces should not harm the children.

Judge not by the looks or colour!!!!!

Buy- Back of sharesMeaning

Methods of pr-purchase of shares in the USA

2. Fixed price tender offer

Method-3. Dutch auction share repurchases

4.Equal access buy-backs

Employees stock option repurchase

on-market buy-backs and minimum holding buy-back

Contradicting sections on Buyback of shares in India

Section-77 of the Companies Act

Other sections to protect the interest of outsiders

Debentures can not be issued to redeem preference shares

Rules for redemption of preference shares

What is the mechanism of using revenue profit to CRR account?

If there is no revenue profits?

If free reserves used For redemption

Steps from Left to right

Revenue profit to Be transferred to CRR account

Redemption of Preference shares

CRR to Fully paid up Bonus shares

Bonus shares to Equity shares

Divisible profits or Profits for redemption

Not divisible/Capital profits

If loss occurred due to sale of Any asset

Set off such capital with Capital reserve

Set off against revenue Profit. the balance is DIVISIBLE PROFITS

Buy back of shares( Sec.77A)

Buy back of shares

Buy back and Companies Act

Maximum Buy back

Buy-Back from whom?

Do your house hold work Without giving excuses.

Help your father/mother in cooking

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