Redemption of Preference Shares: How Much Fresh Issue Is Really Needed?
Prem Kumar Ltd has 30,000 8% redeemable preference shares of ₹100 each, fully paid, which the board intends to redeem on 1 July 2025 at ₹102 per share. On 31 March 2025 the reserves are: General Reserve ₹10,00,000; Profit & Loss surplus ₹5,00,000; Dividend Equalisation Reserve ₹3,00,000; Capital Reserve ₹4,00,000 (arising from sale of a division and realised in cash); Securities Premium ₹2,00,000; Revaluation Reserve ₹6,00,000. The finance director proposes to issue 80,000 equity shares of ₹10 each at par, apply the capital reserve, create the statutory capital redemption reserve, and still declare an equity dividend of ₹2,00,000 after redemption. The company's banker has agreed to provide any cash float required. The board has asked for a note confirming whether the proposal is legally and technically workable and, if not, what the minimum fresh issue must be.
1. Compute the amount that must be transferred to the Capital Redemption Reserve (CRR) and evaluate whether the proposed ₹8,00,000 fresh issue is adequate.
Read the worked answer
CRR requirement. Section 55 read with Section 69 requires a CRR equal to the face value of shares redeemed less the proceeds of a fresh issue made for the purpose. Face value redeemed = 30,000 × ₹100 = ₹30,00,000. Fresh issue = ₹8,00,000. CRR = 30,00,000 − 8,00,000 = ₹22,00,000.
Profits available. CRR must be created out of profits available for dividend: General Reserve ₹10,00,000 + P&L ₹5,00,000 + Dividend Equalisation Reserve ₹3,00,000 = ₹18,00,000.
The Capital Reserve of ₹4,00,000 is realised in cash and is therefore a free reserve that may fund the redemption, but it is not a profit and cannot be used to create the CRR. The Revaluation Reserve is unrealised and is not a free reserve at all. Securities Premium of ₹2,00,000 may be applied only towards the redemption premium of ₹60,000 (30,000 × ₹2), not towards the CRR.
Conclusion. Profits of ₹18,00,000 fall short of the CRR of ₹22,00,000 by ₹4,00,000. The ₹8,00,000 fresh issue is therefore inadequate; the scheme cannot be implemented as proposed.
2. If the company issues ₹14,00,000 of fresh equity at par and still wishes to pay the ₹2,00,000 dividend, compute the CRR and verify that the cash resources are sufficient.
Read the worked answer
CRR. 30,00,000 − 14,00,000 = ₹16,00,000.
Use of profits. Total profits = ₹18,00,000. Of this, ₹16,00,000 is capitalised by transfer to CRR and ₹2,00,000 is paid as dividend. The retained profits left to fund the cash redemption are therefore ₹18,00,000 − ₹2,00,000 = ₹16,00,000.
Cash check.
| Sources | ₹ |
|---|---|
| Fresh issue | 14,00,000 |
| Capital Reserve (realised) | 4,00,000 |
| Profits retained (after dividend) | 16,00,000 |
| Total | 34,00,000 |
| Applications | ₹ |
|---|---|
| Redemption of preference capital | 30,00,000 |
| Premium on redemption (from Securities Premium) | 60,000 |
| Equity dividend | 2,00,000 |
| Total | 32,60,000 |
Cash surplus = ₹1,40,000, so the scheme is funded. The CRR of ₹16,00,000 is exactly supported by profits, and no reserve that is not a profit has been used to create it.
3. The CFO argues that (i) the revaluation reserve can be used because it is a reserve, and (ii) after redemption the CRR can be used to pay dividends. Comment.
Read the worked answer
(i) Revaluation reserve. A revaluation reserve arises from restating an asset, not from realised profits, and is expressly excluded from free reserves. It cannot be applied towards redemption of preference shares, cannot be used to create the CRR, and cannot be used to pay dividends while the revaluation remains unrealised. Only a reserve realised in cash, such as the Capital Reserve here, can help fund the cash redemption, and even then it cannot substitute for profits in the CRR entry.
(ii) Use of CRR. The CRR is a capital reserve created by capitalising profits. It is not a free reserve and is available only for a bonus issue of fully paid shares; it cannot be used to pay dividends, to absorb losses, or to fund a further redemption. The CFO's suggestion would effectively reverse the capital maintenance that Section 69 is designed to protect.
A useful control point: the amount of profits genuinely available for dividend after this redemption is nil in the first proposal and only ₹2,00,000 in the second; the apparent ₹18,00,000 of 'reserves' is largely consumed by the statutory capitalisation.