It is normal that companies issue bonus equity shares all the time to existing equity shareholders out of their free reserves. However, in the past, Indian companies have also capitalised their reserves and surplus to issue either redeemable preference shares or debentures to optimally structure their capital.
In 2007, RBI amended the regulations whereby optionally convertible or redeemable instrument issued to non-resident investors were treated at par with external commercial borrowings. That move has limited options available to the Indian companies to raise funds from non-resident shareholders through optionally convertible instruments. The circular to the effect continues to remain in force as the new circular only allows issue of bonus shares out of existing reserves without raising funds.
So, what is the reason for issuing a clarification on the issue of bonus redeemable preference shares or non-convertible debentures According to RBI, the central bank was receiving a reference from some Indian companies regarding the issue of these instrument to shareholders, including non-resident ones, through a high court-approved Scheme of Arrangement under Section 391 of the Companies Act, 1956. RBI was granting permission on a case-to-case basis and therefore, in order to rationalise and simplify the process, it felt that an amendment in the regulations can create enabling policy for issuing these instruments.
The circular suggests that this general permission route is available only when these instruments are issued through a Scheme of Arrangement approved by the jurisdictional High Court. Therefore, companies which intend to issue bonus preference shares or debentures pursuant to board resolutions/shareholders' approval would still need to approach RBI (if non-residents are shareholders) to seek approval on a case-to-case basis.
RBI has clarified that issue of such instruments would also be subject to 'no objection' from the income tax authorities. This requirement may prove to be hurdle due to lack of specific enabling provisions under the tax laws. One needs to see how under the existing framework of law, the tax authorities can provide 'no objection' certification to the issuing of such instruments. One may argue that there was no need to mandate such 'no objection' from the tax authorities as currently no such approval is required where companies intend to reward their shareholders in other forms, like the issue of bonus equity shares, buyback of shares, capital reduction, dividend, etc. At the same time, it can also be argued that RBI has mandated the 'no objection' from the taxman on the lines of the Companies Act, 2013 whereby companies need to intimate a host of regulators, including tax authorities, while implementing the Scheme of Arrangement.
Irrespective of the aforementioned procedural aspects, why should one still consider capitalising the existing reserve by issuing redeemable preference shares or debentures Unlike bonus equity shares, it allows companies to distribute surplus cash in a calibrated manner over a period of time and reward the shareholders. There also have been situations where companies are sitting on substantial reserves but do not have immediate liquidity available as funds are blocked in the projects. A careful planning around this can provide liquidity to the promoters without diluting or pledging equity stake. At the same time, it does not compromise on the current capital commitments of the company. As far as small and minority investors, who may not be willing to wait for redemption or maturity, are concerned, it provides them an exit opportunity.
At present, many companies are sitting on piles of cash for the lack of viable investment opportunities. They could think of returning some of the cash through these instruments in a staggered manner rather than having treasury operations which generally sends confusing signals to the investors on the business strategy of the company as well leading to sub-optimal returns on capital. It can also be used by the large number of companies which are likely to realise locked up capital in the near future on account of divestment of non-core activities, better visibility of realisation, improved economic environment, etc.
Alok Mundra, director, KPMG , also contributed to the article
The author is co-headTax, KPMG.
Views are personal