Query

1. Under the provisions of Section 80A of the Companies Act, 1956, preference shares of a company were required to be redeemed in the year 1993. Due to various reasons, the company could not redeem these preference shares. The notes to accounts appeared as below:



“Arrears of dividend on cumulative preference shares upto the year ending on 31st March, 1996 amount to Rs. ABC.”



The total amount of issued, subscribed and paid-up preference capital is Rs. 5 lakhs consisting of 5,000 11% cumulative redeemable preference shares each of Rs. 100 fully paid-up.



2. The querist has sought the opinion of the Expert Advisory Committee on the following issues:



(i) Is it correct for the company to show such preference capital as capital or should it be shown as current liability after the shares have become due for redemption?



(ii) Whether the company should account for the arrears of divided as a liability or a contingent liability?



(iii) While working out the net worth of the company for various provisions under the law whether such preference capital should be treated as capital or as a liability and in particular for the purpose of Section 58A, Section 370 and Section 372 of the Companies Act, 1956, and for working out the net worth under the provisions of SICA?



(iv) What should be the treatment in respect of arrears of divided for any of the aforesaid provisions mentioned in (iii) above?




Opinion May 19, 1997


1. The Committee notes that Section 80A the Companies Act, 1956, requires as below:



“(1) Notwithstanding anything contained in the terms of issue of any preference shares, every preference share issued before the commencement of the Companies (Amendment) Act, 1988-



(a) which is irredeemable, shall be redeemed by the company within a period not exceeding five years from such commencement, or



(b) which is not redeemable before the expiry of ten years from the date of issue thereon in accordance with the terms of its issue and which had not been redeemed before such commencement, shall be redeemed by the company on the date on which such share is due for redemption or within a period not exceeding ten years from such commencement, whichever is earlier:



Provided that where a company is not in a position to redeem any such share within the period aforesaid and to pay the dividend, if any, due thereon (such shares being hereinafter referred to as unredeemed preference shares), it may, with the consent of the Company Law Board, on a petition made by it in this behalf and notwithstanding anything contained in this Act, issue further redeemed preference shares equal to the amounts due (including the dividend thereon), in respect of the unredeemed preference shares, and on the issue of such further redeemable preference shares, the unredeemed shares shall be deemed to have been redeemed.



(2) Nothing contained in section 106 or any scheme referred to in sections 391 to 395, or in any scheme made under section 396, shall be deemed to confer power on any class of shareholders by resolution or on any court or the Central Government to vary or modify the provisions of this section.



(3) If any default is made in complying with the provisions of this section, -



(a) The company making such default shall be punishable with fine which may extend to one thousand rupees for every day during which such default continues; and



(b) Every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years and shall also be liable to fine.”



2. The Committee further notes that as per Part I of Schedule VI to the Companies Act, 1956, the preference shares are required to be disclosed under the head ‘Capital’. The Committee is, therefore, of the view that until the preference shares are actually redeemed, they should continue to be shown under the head ‘Capital’. Thus, in the present case since the preference shares are due for redemption under the provisions of Section 80A, but are not redeemed, they should be disclosed under the head ‘Capital’. However, the fact of these being due for redemption under the provisions of Section 80A of the Companies Act, 1956, should be clearly disclosed in a manner that a reader is aware of the non-compliance with the provisions of section 80A.



3. With regard to arrears of preference dividend, the Committee notes from the proviso to section 80A of the Companies Act, 1956, (reproduced at para 1 above) that if the company is not in a position to pay the same then they may be paid by issuing redeemable preference shares of equivalent amount. The Committee is, accordingly, of the view that a liability in respect of the arrears of preference dividends is thereby created by virtue of operation of law. Accordingly, the Committee is of view that a provision in this regard should be made in the accounts.



4. The Committee further notes that Section 80A(3) (a) requires imposition of fine which may extend to one thousand rupees for every day during which such default continues. The Committee is of the view that a provision or a disclosure of contingency for the same may also have to be made at an amount based on the relevant facts and circumstances of the case, in terms of the requirements of Accounting Standard (AS) 4 on ‘Contingencies and Events Occurring After the Balance Sheet Date’, issued by the Institute of Chartered Accountants of India.



5. The Committee also notes that the Explanation to Rule 3 of Companies (Acceptance of Deposits) Rules, 1975, explains as below:



“For the purpose of this Rule, in arriving at the aggregate of the paid-up share capital and free reserves of a company, there shall be deducted from the aggregate of the paid-up share capital and free reserves as appearing in the latest audited balance sheet of the company, the amount of accumulated balance of losses, balance of deferred revenue expenditure and other intangible assets, if any, as disclosed in the said balance sheet.”



6. The Committee further notes sub-section (1) of section 370 of the Companies Act, 1956, which, inter alia, states as below:



“The aggregate of the loans made to all bodies corporate shall not exceed without the prior approval of the Central Government-



(a) such percentage of the aggregate of the subscribed capital of the lending company and its free reserves as may be prescribed where all such other bodies corporate are not under the same management as the lending company;



(b) Such percentage of the aggregate of the subscribed capital of the lending company and its free reserves as may be prescribed where all such other bodies corporate are under the same management as the lending company.”



7. The Committee also notes sub-section (2) of section 372 of the Companies Act, 1956, which, inter alia, states as below:



“The Board of Directors of the investing company shall be entitled to invest in any shares of any other body corporate upto such percentage of the subscribed equity share capital, or the aggregate of the paid up equity and preference share capital, of such other body corporate, whichever is less, as may be prescribed:



Provided that the aggregate of the investments so made by the Board in all other bodies corporate shall not exceed such percentage of the aggregate of the subscribed capital and free reserves of the investing company, as may be prescribed:



Provided further that the aggregate of the investments made in all other bodies corporate in the same group shall not exceed such percentage of the aggregate of the subscribed capital and free reserves of the investing company, as may be prescribed.”



8. The Committee also notes section 3(ga) of the Sick Industrial Companies (Special Provisions) Act, 1985, which defines net worth as below:



“Net worth means the sum total of the paid-up capital and free reserves. For this purpose, free reserves means all reserves credited out of the profits and share premium account but does not include reserves credited out of the re-evaluation of assets, write back of depreciation provisions and amalgamation.”



9. The Committee is of the view that as the law stands at present, the preference capital continues to be a part of capital (even though it has become due for redemption) for the purposes of sections 58A, 370 and 372 of the Companies Act, 1956, as well as for the purpose of computation of net worth under SICA. With regard to arrears of preference dividend, the Committee is of the view that since by operation of law, they become the liability of the company, the same should be adjusted in arriving at the figure of free reserves for the purposes of the aforesaid provision of the Companies Act, 1956, and SICA.



10. Based on the above, the Committee is of the following opinion for issues raised at para 3 of the query:



(i) Preference shares due for redemption should be shown under the head ‘Capital’. However, it should be clearly disclosed that they are due for redemption as per the provisions of the Section 80A of the Companies Act, 1956, and that the company has not been able to comply with the provisions of section 80A.



(ii) Arrears of cumulative preference dividend should be shown as a liability. The impact of the penalty under section 80A should be assessed and appropriately accounted for or disclosed as per para 4 above.



(iii) For the purpose of Section 58A, Section 370, Section 372 of the Companies Act, 1956, and SICA, preference shares to be redeemed should be treated as a part of capital.



(iv) Arrears of cumulative preference dividend, being a liability of the company, should be adjusted for arriving at the amount of free reserve for the purposes of the provisions of Sections 58A, 370 and 372 of the Companies Act, 1956, and SICA.