Creation of Capital Redemption Reserve Account

Reserves can be classified based on the source of earnings. A revenue reserve is created out of profits generated from the trading activities of a company and a capital reserve is created out of the profits which are capital in nature such as revaluation of assets, write-back of depreciation and amalgamation etc. When a company incurs capital losses, the fund from the capital reserve is used to write-off the same.

A ‘free reserve’ is defined under the Companies Act, 2013 (“Companies Act”) as any reserve available for distribution of dividends as per the last audited balance sheet. The definition excludes any amount earned from unrealized gains, notional gains or revaluation of assets from being treated as a free reserve. Similarly, any change in carrying the amount of an asset or liability in equity will not be a part of a free reserve.

Capital redemption reserve account is a type of reserve maintained by a company limited by shares and as the name suggests this reserve deals with shares which are redeemable. The shares which are purported to be redeemed are paid out of the profits of a company. For this purpose, out of the profits, an amount equivalent to the nominal value of the share supposed to be redeemed is transferred to a reserve. This reserve is called a capital redemption reserve account.

Capital Redemption Revere is also created when a company buys it owns shares which reduces its share capital.

Suppose, the fresh equity shares or preference shares are issued to redeem the old preference shares, in this case the difference between the face value of preference shares and fresh shares issued will be transferred to capital redemption reserve account.

The capital redemption reserve fund is transferred from undistributed profits  i.e general reserves, profit or loss account.

The amount of capital reserve cannot be used for redemption of preference shares. Therefore, no amount is transferred in to capital redemption reserves out of capital reserves.

A company may issue preference shares which can be redeemed within a period of twenty years from the date of issue. However, it is subject to the following conditions as prescribed in the Companies Act:

• The redemption must be out of the profits of the company which would otherwise be distributed as dividends or out of the earnings of a fresh issue of shares (made for the purposes of such redemption);
• The Articles of Association of the company must permit the same;
• Only fully paid-up shares can be redeemed;
• In case the premium is payable at the time of redemption for certain class of companies (as prescribed) which complies with the accounting standards under Section 133 of the Companies Act, it must be paid out of the profits of the company before the shares are redeemed.
• The company has to maintain a capital redemption reserve account (the provisions relating to the reduction of the share capital of a company will apply as if the Capital Redemption Reserve Account is paid-up share capital of the company);
• If the premium is payable for preference shares issued on or before the commencement of the Companies Act, before such shares are redeemed, the premium must be paid out of profits of the company or out of the securities premium account maintained by the company.

The importance of creation of capital redemption reserve account is due to following reasons:

• To protect the interest of creditors.
• To maintain working capital.

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