Working Note on Preference Shares
According to Section 55 of the Companies Act, 2013, a company limited by shares cannot issue any preference shares which are irredeemable. However, 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.
Definition of Preference Shares
According to Section 43 of the Companies Act, 2013, the share capital of a company limited by shares can be divided into:
- Equity share capital: which includes shares with voting rights or with differential rights as to dividend, voting, or otherwise.
- Preference share capital: which carries a preferential right with respect to payment of dividend and repayment of capital in case of winding up.
Types of Preference Shares
- Cumulative Preference Shares: Dividends accumulate if not paid in any year and are paid in arrears before equity dividends.
- Non-Cumulative Preference Shares: Dividends do not accumulate if not paid in any year.
- Redeemable Preference Shares: These shares are redeemed by the company after a fixed period of time.
- Irredeemable Preference Shares: These shares cannot be issued under the Companies Act, 2013.
- Convertible Preference Shares: These shares can be converted into equity shares after a specified period.
- Non-Convertible Preference Shares: These shares cannot be converted into equity shares.
- Participating/Non-participating: Participating preference shares give their holders the right to receive a fixed dividend and participate in surplus profits of the company after equity dividends.
Issue and Redemption Conditions
A company limited by shares may issue preference shares liable to be redeemed within 20 years from the date of issue under the following conditions:
- The shares must be fully paid.
- The shares must be redeemed out of 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 purpose of redemption.
- For companies engaged in setting up and dealing with infrastructure projects, redeemable preference shares can be issued for a period exceeding 20 years but not exceeding 30 years.
Rights of Preference Shareholders
- Dividend: Preference shareholders are entitled to receive dividends before equity shareholders.
- Repayment of Capital: Preference shareholders have the right to be paid back their capital before equity shareholders in the event of winding up.
- Voting Rights: Preference shareholders generally do not have voting rights, except in certain circumstances like resolutions directly affecting their rights, non-payment of dividends for a period of two years or more, etc.
Key Compliance Requirements
- Board and Shareholder Approval: The issuance of preference shares requires approval from the board of directors and shareholders through a special resolution.
- Filing with Registrar of Companies (ROC): Necessary filings must be made with the ROC, including details of the terms of issue and the special resolution passed.
- Maintaining Records: Companies must maintain proper records of preference shares issued, redeemed, and outstanding.
- Return of Allotment: A return of allotment of preference shares (Form PAS-3) must be filed with the ROC within 30 days of the allotment.
Advantages of Preference Shares
Fixed Dividends & Priority: Preference shareholders receive dividends at a fixed rate, providing a steady income stream. In case of liquidation, preference shareholders have a higher claim on assets and earnings compared to equity shareholders, making them less risky.
Flexibility for Issuers & Non-Dilution: Companies can structure preference shares in various ways. Issuing preference shares does not dilute the control of existing equity shareholders since preference shareholders typically do not have voting rights.
Disadvantages of Preference Shares
Higher Cost & Obligation: The fixed dividend obligation can be more costly than variable dividends on equity shares. For redeemable preference shares, redemption can be a financial burden. Dividends are not tax-deductible for the company, unlike debt interest payments.
No Voting Rights & Less Capital Appreciation: Preference shareholders usually do not have voting rights and do not benefit from capital appreciation in the same way as equity shares.