redemption or purchase of shares out of capital

7/30/2019 Redemption or purchase of shares out of capital

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Private companies: redemption or purchase of shares outof capitalThe Companies Act 1981 introduced a new power for a private company to redeem /purchase its own shares where either it has insufficient distributable profits for the purpose or it cannot raise the amount required by a new issue. Previouslyit would have had to apply to the court for capital reduction (which you will learn about in Chapter 9). The 1981 legislation made it far easier to achieve thesame objectives, in terms of both time and expense.The full details of the various matters which must be dealt with by private companies who pursue this option are beyond the scope of this textbook. If you wishto go into this topic in greater detail, you will need to consult a book on company law. For our purposes, a very brief outline is as follows:1 The private company must be authorised to redeem or purchase its own shares out of capital

by its Articles of Association.2 Permissible capital payment is the amount by which the price of redemption orpurchase

exceeds the aggregate of (a) the companys distributable profits and (b) the proceeds of any new

issue. This means that a private company must use its available profitsand any share proceeds

before making a payment out of capital. (This is dealt with in greater detail in the next section.)3 Directors must certify that, after the permissible capital payment, the compa

ny will be able tocarry on as a going concern during the next twelve months, and be able to pay its debts imme-

diately after the payment and also during the next twelve months.4 The companys auditors make a satisfactory report.

Activity5.3 Why do you think the rules are less restrictive for private companies?

5.8 Permissible capital payments1 Where the permissible capital payment is less than the nominal value of shares redeemed /

purchased, the amount of the difference shall be transferred to the capi

tal redemption reservefrom the profit and loss appropriation account (or from undistributed profits).2 Where the permissible capital payment is greater than the nominal value of shares redeemed /

purchased, any non-distributable reserves (e.g. share premium account, capital redemption

reserve, revaluation reserve, etc.) or fully paid share capital can be reduced by the excess.

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Part 2 l CompaniesThis can best be illustrated by taking two companies, R and S, with similar account balances before the purchase/redemption, but they are redeeming their shareson different terms:(Note: To ensure maximum clarity, the values used have been kept unrealisticallylow.)

Exhibit 5.7


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Before Dr Cr AfterCompany R Net assets (except bank) 2,500 2,500Bank 7,500 (B2) 4,000 3,50010,000 6,000Ordinary shares 1,000 1,000Preference shares 4,000 (A1) 4,000 -Non-distributable reserves 2,000 2,000Capital redemption reserve (C2) 3,000 3,000Preference share purchase - (B1) 4,000 (A2) 4,0007,000Profit and loss 3,000 (C1) 3,00010,000 6,000The preference shares were redeemed at par, 4,000. No new issue was made.(A1) and (A2) represent transfer of shares redeemed/purchased.(B1) and (B2) represent payment to shareholders.Therefore pay 4,000Less Profit and loss account (3,000)Permissible capital payment 1,000Nominal amount of shares redeemed/purchased 4,000Less Permissible capital payment (1,000)Deficiency to transfer to capital redemption reserve (C1 and C2) 3,000

The steps taken were: Dr Cr

(A1) Preference shares 4,000(A2) Preference share purchase 4,000(B1) Preference share purchase 4,000(B2) Bank 4,000(C1) Profit and loss 3,000(C2) Capital redemption reserve 3,000Before Dr Cr AfterCompany S Net assets (except bank) 2,500 2,500Bank 7,500 (D2) 7,200 30010,000 2,800Ordinary share capital 1,000 1,000Preference shares 4,000 (A1) 4,000 -

Non-distributable reserves 2,000 (C1) 200 1,800Capital redemption reserve - -Preference share purchase (D1) 7,200 (A2) 4,000(B2) 3,000(C2) 2007,000 2,800Profit and loss 3,000 (B1) 3,000 -10,000 2,800

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Chapter 5 l Companies purchasing and redeeming their own shares and debentures

The preference shares were redeemed/purchased at a premium of 80%. No new issuewas made.(A1) and (A2) represent shares redeemed /purchased.(B1) and (B2) are transfers to redemption /purchase account of part of source offunds.(D1) and (D2) are payment to shareholders.


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Therefore pay 7,200Less Profit and loss account (3,000)Permissible capital payment 4,200Permissible capital payment 4,200Less Nominal amount redeemed/purchased (4,000)Excess from any of non-distributable reserves (or capital) (C1 and C2) 200The steps taken were: Dr Cr(A1) Preference shares 4,000(A2) Preference share purchase 4,000(B1) Profit and loss 3,000(B2) Preference share purchase 3,000(C1) Non-distributable reserves 200(C2) Preference share purchase 200(D1) Preference share purchase 7,200(D2) Bank 7,200

redemption or purchase of shares out of capital

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