Bonus debentures, preference shares may become attractive

There are various ways in which a company can reward its shareholders. Cash dividend, bonus shares and buybacks are considered traditional. Typically, the decision is based on what the company proposes. When the company does not consider any involvement necessary from shareholders on the nature of the payout, a bonus issue or a cash dividend is approved. It is only when the company wishes to give shareholders an option, that a buyback is proposed.

Though bonus debentures are not a new introduction in practice, the recent notification by the Reserve Bank of India (RBI) granting general permission for issue of non-convertible/ redeemable preference shares or debentures by way of a bonus is indeed one of a kind. It is truly a bonus announcement since hitherto, the RBI was granting permission in such matters only on a case-to-case basis. The general permission route is now available where the bonus issue is out of general reserves of the company and a no objection is obtained from income tax authorities.

The necessary amendments to the applicable regulations under the Foreign Exchange Management Act (FEMA) governing transfer or issue of security by/to a person resident outside India were also issued followed by the RBI's circular to the authorised dealer banks. This enabling provision has also been captured under the consolidated foreign direct investment (FDI) policy issued in April 2014.
The RBI notification amending the relevant regulations under the FEMA stipulates that such distribution as bonus to shareholders resident outside India would be subject to certain conditions.

The original acquisition of shares/ convertible debentures of the Indian company by non-resident shareholders entitling them to hold non-convertible redeemable preference shares or debentures should have been in accordance with the applicable regulations/ conditions under the FEMA and also in accordance with the Companies Act. The terms and conditions stipulated in the scheme approved by the court in India should also have been complied with. It is also specified that the issuer Indian company shall not engage in any activity/ sector that is prohibited for FDI.

As regards fresh issues, the RBI circular clarifies that the general permission is a specific and limited one subject to satisfaction of the conditions stipulated. Any other issue of preference shares and/ or debentures under the FDI scheme would continue to be governed by the circulars issued in 2007 which require the preference shares and debentures issued by an Indian company to a non-resident party to be fully and mandatorily convertible into equity.

The ability to issue bonus debentures itself is quite attractive given that the value of the equity shares of the company does not stand diluted. Although the issue would be treated as dividend, with the company having to make payment towards dividend distribution tax, the company will be entitled to the benefit attached to interest payment during the tenure of such bonus debentures. The capital base remaining constant is also considered by companies as key to their periodic performance review.

In the hands of the shareholder as well, where there is a 1:1 bonus issue in the form of shares, there is no immediate benefit since the value per share remains almost the same given the increased capital base. A bonus debenture, on the other hand, does not dilute the equity share value, rewards the shareholder with interest on the debentures during the term and the redemption price payable on maturity. A bonus preference share may not have all the benefits above, but may still be an alternate to bonus issue of equity shares.

Interestingly, the amendment to the regulations under the FEMA is to the one that deals with issue and acquisition of shares after mergers, demergers or amalgamation and not the regulation that deals with the acquisition of bonus shares.

The existing regulations under the FEMA relating to bonus issue only contemplate an Indian company issuing bonus shares to its non-resident shareholders, with such bonus shares being subject to the same conditions applicable to the original shares, which include restrictions on repatriability.

The existing regulations under the FEMA relating to issue and acquisition of shares after a court approved merger, demerger or amalgamation contemplate the transferee company or the new company issuing shares to the shareholders of the transferor company. Such issue of shares is, however, subject to the condition that the percentage holding of the non-resident shareholders should not exceed the percentage approved by any regulatory authority or the applicable sectoral caps.

The companies in question cannot be engaged in any activity prohibited for FDI and should file a report with the RBI within 30 days giving full details of the shares held by the non-resident persons before and after the merger, demerger or amalgamation, as the case may be.

To conclude, the route is available only where the bonus issue is pursuant to a court-approved scheme of arrangement and not otherwise. That said, with the statutory sanction in place, issue of bonus debentures and preference shares may develop as an interesting alternative.

The author is a partner at J. Sagar Associates. Views expressed are personal