Tag: Foreign Direct Investment

Procedure for Registration of Trust under the Indian Trusts Act,1882

Decide the following:

a) Name of the trust

b) Address of the trust

c) Objects of the trust (Charitable or Religious)

d) One settlor of the trust

e) Two trustees of the trust (minimum)

f) Property of the trust: Movable or immovable property (normally a small amount of cash/cheque is given to be the initial property of the trust, in order to save on the stamp duty).

Prepare a Trust Deed on stamp paper of the requisite value. The rates of stamp duty varies from state to state. Kindly check the current rate of stamp duty applicable in your state.

Requirement for registration of Trust Deed with the Local Registrar under the Indian Trusts Act, 1882:

a) Trust Deed on stamp paper of requisite value.

b) One passport size photograph & copy of the proof of identity of the settlor.

c) One passport size photograph & copy of the proof of identity of each of the two trustees.

d) One passport size photograph & copy of the proof of identity of each of the two witnesses.

e) Signature of settlor on all the pages of the Trust Deed.

t) Witness by two persons on the Trust Deed.

Go to the local Registrar and submit the Trust Deed, along with one photocopy, for registration. The photocopy of the Deed should also contain the signature of settlor on all the pages. At the time of registration, the settlor and two witnesses are required to be personally present, along with their identity proof in the original.

The Registrar retains the photocopy and returns the original registered copy of the Trust Deed.

The Societies Registration Act, 1860

The Societies Registration Act, 1860 is legislation in India which allows the registration of entities generally involved in the benefit of society education, health, employment etc.

The British Indian Empire, with a wish to encourage such activities and to promote the formal organisation of groups of likeminded people, incorporated the Act 21 of 1860, in other words, The Societies Registration Act, 1860 (21 of 1860), which came into force on 21 May 1860. The Act continues until today and being an Act of Parliament, comes under the Right to Information Act, wherein the government is legally responsible to give any information requested by any citizen of India with respect to any society.

Closing of a Registered Society

A society is legally registered under the Societies Registration Act, 1860. The Indian Societies Registration Act of 1860 was enacted under the British Raj in India, but is largely still in force in India today. It provides for the registration of literary, scientific and charitable societies. Under the Act societies may be formed, by way of a memorandum of association, by any seven or more people associated for any literary, scientific or charitable purpose. The memorandum of association has to be filed with the Registrar of Societies. The memorandum has to contain the name of the society, its objects, and the names, addresses, and occupations of the members of the governing body, by whatever name it may be called, duly signed for consent by all the members forming the society.

Provisions under the Act

Under Section 13 of the Societies Registration Act, 1860; a number of provisions relating to dissolution of a society and adjustments of its affairs are stated. It is stated that Any number not less than three-fifths of the members of any society may decide and determine that it shall be dissolved, and consequently it shall be dissolved without any delay, or at the time then agreed upon by the members, and all necessary steps are to be taken for the disposal and settlement of the property of the society, its claims and liabilities, according to the rules of the said society applicable thereto, if any were made at the time of the registration of the society and if not, then as the governing body shall find a convenient expedient, provided that, in the incident of any dispute or disagreement arising among the said governing body or the members of the society, the adjustment of its affairs shall be referred to the principal Court of original civil jurisdiction of the district in which the chief building of the society is situated and the Court shall make such order in the matter as it shall deem required by law and practically apt. The assent is necessarily required provided that no society shall be dissolved unless three-fifths of the members shall have expressed a wish for such dissolution by their votes delivered in person, or by proxy, at a general meeting convened for the purpose. There is also a concept of Government consent. It is provided in the aforesaid statute that whenever any Government is a member of, or a sponsor or contributor to, or otherwise interested in any society registered under this Act, such society shall not be dissolved without the consent of the Government of the State where the society was registered. There are also several state amendments given under this section.

Purpose of Society Registration

A society registration can be done for the development of fine arts, science, or literature or else for the diffusion of purposeful knowledge or charitable purposes of political education. According to section 20 of the Society Act, 1860, a society registration can be done for the following purposes:

• Promotion of fine arts.
• Diffusion of political education.
• Grant of charitable assistance.
• Promotion of science and literature.
• Creation of military orphan funds.
• Maintenance or foundation of galleries or public museum.
• Maintenance or foundation of reading rooms or libraries.
• Promotion or diffusion or instruction of useful knowledge.
• Collections of natural history.
• Collections of mechanical and philosophical inventions, designs, or instruments.

Registration of a Society in India

A Society can be created by a minimum of 7 or more persons. Apart from persons from India, companies, foreigners, as well as other registered societies can also register for the Memorandum of association of the society.

Similar to Partnership firms, society can also be either unregistered or registered. But, only the registered societies will be able to withstand consigned properties and/or have an ensemble filed against or by the society.

Society registration is maintained by state governments. Thus, the application for society registration must be created to the specific authority of the state, where the registered office of the society is situated.

For Society registration, the establishing members must agree with the name of society first and then prepare for the Memorandum, followed by Rules & Regulations of the society.

Selection of a Name

When selecting a name for society registration, it is vital to understand that according to Society Act, 1860, an identical or similar name of a currently registered society will not be allowed. Moreover, the proposed name shall not suggest for any patronage of the state government or the government of India or fascinate the provisions of the Emblem & Names Act, 1950.

Memorandum of Association

The Memorandum of Association of the society along with Rules & Regulations of society must be signed by every establishing member, witness by Gazetted Officer, Notary Public, Chartered Accountant, Oath Commissioner, Advocate, Magistrate first-class or Chartered Accountant with their official stamping and complete address.

The memorandum must contain the name of the society, the object of the society. Also, it consists of details of members of the society registration along with their names, addresses, designations, and occupations. The following document has to be prepared, submitted and signed for the sake of registration:

• Requesting society registration by providing covering letter, signed by all establishing members.
• Duplicate copy of Memorandum of Association of society along with certified copy.
• Duplicate copy of Rules & Regulations of society along with duplicate copy duly signed by all establishing members.
• Address proof of registered office of society as well as no-objection certificate (NOC) issued by landlord.
• Affidavit avowed by secretary or president of society declaring relationship among subscribers.
• Few minutes of meeting regarding the society registration along with providing some essential documents.

Dissolution of Society by Court

As per the provisions of this act, on the application of the Registrar under section 13A or under section 24 or on an application made by not less than one- tenth of the members of a society registered under this Act, the Court of competent jurisdiction referred to in section 13 may make an order for the dissolution of the society on any of the following grounds, viz.

(a) That the society has contravened any provision of this Act or of any other law for the time being in force and it is just and equitable that the society should be dissolved

(b) That the number of the members of the society is reduced below seven;

(c) That the society has ceased to function for more than three years preceding the date of such application;

(d) That the society is unable to pay its debts or meet its liabilities; or

(e) That the registration of the society has been cancelled under section 12D on the ground that its activities or proposed activities have been or are or will be opposed to public policy.

It has to be noted that when an order for the dissolution of a society is made under sub-section (1) or sub-section (2), all necessary steps for the disposal and the settlement of the property of the society, its claims and liabilities and any other adjustment of its affairs take place in manner as the Court may direct.

Matters of profit upon dissolution

Under section 14 of the act, upon the dissolution of the society, no member is entitled to receive any profits. If upon the dissolution of a society registered under this Act there remains, after the satisfaction of all its debts and liabilities, any property whatsoever, the same will not be paid to or disseminated and distributed among the members of the said society or any of them, but is required by law to be given to some other society which is to be determined by the votes of not less than three-fifths of the members present individually or by proxy at the time of the dissolution, or, in default thereof, by such Court as aforesaid. It is important to note here that this clause does not to apply to the Joint-Stock Companies. Provided, however, that this clause shall not apply to any society which has been founded or established by the contributions of share-holders in the nature of a Joint-Stock Company

The new issue market / activity was regulated by the Controller of Capital Issues (CCI) under the provisions of the Capital Issues (Control) Act, 1947 and the exemption orders and rules made under it. With the repeal of the Act and the consequent abolition of the office of the CCI in 1992, the protection of the interest of the investors in securities market and promotion of the development and regulation of the market/ activity became the responsibility of the SEBI.

Merchant Bankers (Managers to the Issue):

SEBI regulations 1992 prescribes that all public issues should be managed by at least one merchant banker functioning as Lead manager or Managers to the Issue.

“Merchant banker means any person/institution who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory services in relation to such issue management.” [Sec 2(cb) SEBI (Merchant Bankers) (Third Amendment) Regulations, 2006]

Depending on the size of the issue there can be more than one manager to the issue. If the size exceeds Rs. 400 crores there can be five or more managers as agreed by SEBI. These Managers to the issue assist the promoters in designing the capital structure, drafting the prospectus and application forms, listing of shares, appointment of registrars and other operators in the new issue, arrangement of long term loans- marketing of public issues etc. The lead manager prepares Draft Red Herring Prospectus (RHP) and is responsible for any irregularities in the same. The company should enter into a memorandum of understanding with the managers to the issue in the form prescribed by SEBI.

The lead merchant bankers appointed by the Issuer Company are referred to as the Book Running Lead Managers (BRLM) or Book Runners (If the issue is through book building process).

Underwriters

Underwriters: Another important intermediary in the new issue/ primary market is the underwriters to issue of capital who agree to take up securities which are not fully subscribed.

They make a commitment to get the issue subscribed either by others or by themselves. Though underwriting is not mandatory after April 1995, its organization is an important element of primary market. Underwriters are appointed by the issuing companies in consultation with the lead managers / merchant bankers to the issues.

Methods of Underwriting

An underwriting agreement may take any of the following forms:

• Standing behind the Issue:

Under this method the underwriter guarantees the sale of a specified number of shares within a specified period. If the public do not subscribe to the specified amount of issue, the underwriter will buy the balance. It is also called full underwriting.

• Outright Purchase:

In this method the underwriters purchases the entire issues at an agreed price and sell them to investors.

• Consortium Method:

In mega issues several underwriters join together to underwrite. They form a consortium/syndicate for this purpose. It is also called syndicate underwriting.

• Partial Underwriting:

The underwriter undertakes the guarantee for only a part of the issue offered to the public and his liability is limited to the extent of unsubscribed portion of the issue underwritten by him under this method.

• Joint Underwriting:

The issuing company may enter into underwriting agreement with more than one underwriter in case of large issues. Each under-writer undertakes the guarantee for the issue of a certain portion of the whole issue offered to the public and shares the risk.

• Firm Underwriting:

Under this method, the underwriter undertakes to buy or subscribe a certain number of shares irrespective of the subscription from the public. Underwriter will be liable for shares underwritten as well as that part of issue unsubscribed by the public.

• Sub-Underwriting:

Under this method, the underwriter enters into agreement with some other underwriters to undertake guarantee for the issue of whole or part of the issue under-written by him.

Underwriting has the following advantages:

(i) Issuing company is assured of procuring the required funds from issue through underwriting.

(ii) Under writers supply expert advice and valuable information with regard to capital market conditions, general response of the investors etc. to the issuing company.

(iii) Underwriting helps promoters to retain control over the management of the company, because they distribute the issue over a large number of investors scattered in different part of the country.

(iv) Prestige of the underwriting agencies increases the goodwill of the issuing company.

(v) Prospective investors are also benefited through the service of underwriters as they provide essential information about the issuing companies and encourage them to save money is corporate securities.

Underwriters charge a commission for their service which is known as underwriting commission. The underwriters must be registered with SEBI. There are three SEBI registered underwriters now. E.g., Citicorp Capital Markets Ltd., State Bank of India etc.

Brokers to the Issue

Brokers are persons mainly concerned with the procurement of subscription to the issue from the prospective investors. The appointment of brokers is not compulsory and the companies are free to appoint any number of brokers. The managers to the issue and the official brokers organize the preliminary distribution of securities and procure direct subscription from as large or as wide a circle of investors as possible. A copy of the consent letter from all the brokers to the issue, should be filed with the prospectus to the ROC. The brokerage applicable to all types of public issue of industrial securities is fixed at 1.5%, whether the issue is underwritten or not. The listed companies are allowed to pay a brokerage on private placement of capital at a maximum rate of 0.5%. Brokerage is not allowed in respect of promoters’ quota including the amounts taken up by the directors, their friends and employees, and in respect of the rights issues taken by or renounced by the existing shareholders. Brokerage is not payable when the applications are made by the institutions/ bankers against their underwriting commitments or on the amounts devolving on them as underwriters consequent to the under subscription of the issues.

Registrars to the Issue (Registrar and Share Transfer (R&T) Agents):

R&T agent plays a significant role in a public issue along with the lead managers. Registrars are persons appointed in consultation with lead managers to assist the issue management functions. Their work relates to pre-issue management, management during the currency of issue, pre- allotment Work, allotment work and post allotment work.

It is their duty to collect the application forms from bankers to the issue, process them for allotment and issue certificate of allotment.

Major functions of registrars can be listed as follows:

(i) Design and draft the format of application form for the merchant banker or lead manager.

(ii) Collect application forms from banks.

(iii) Scrutinize application forms.

(iv) Finalize the allotment as per the basis approved by the stock exchange.

(v) Ensures that the corporate action for crediting of shares to the demat accounts of the applicants is done

(vi) Print refund orders and letters of allotment.

(vii) Submit all statements to the company for their final approval.

(viii) Help the company in getting the shares listed.

Bankers to an Issue

The bankers to an issue are engaged in activities such as acceptance of applications along with application money from the investor in respect of capital and refund of application money.

Registration: To carry on activity as a banker to issue, a person must obtain a certificate of registration from the SEBI. The applicant should be a scheduled bank. Every banker to an issue had to pay to the SEBI an annual free for Rs. 5 lakh and renewal fee or Rs. 2.5 lakh every three years from the fourth year from the date of initial registration. Non-payment of the prescribed fee may lead to the suspension of the registration certificate.

Syndicate Members:

The Book Running Lead Managers to the issue appoint the Syndicate Members, who enter the bids of investors in the book building system. Syndicate Members are commercial or investment banks registered with SEBI who also carry on the activity of underwriting in IPO.

They work as intermediaries for Issuer Company and the buyers of the IPO stocks. Investors submit their bids for IPO shares through Syndicate Members appointed by the Issuer Company. They are also known as ‘the Members of the Syndicate’. The Members of the Syndicate circulate copies of the Red Herring Prospectus along with the bid cum application form to potential investors. After receiving the bid for IPO Shares from an investor, Syndicate Member enters bidding detail into the electronic bidding system and generates a Transaction Registration Slip (TRS) for each price and demand option and gives the same to the bidder.

An information circular is a document for a company’s shareholders outlining important matters on the agenda at the annual shareholders’ meeting or a special shareholders’ meeting. The information circular also solicits proxy votes and provides procedures for voting on key issues.

Some companies call an information circular a “Management Information Circular,” a “Notice of Annual Meeting of Shareholders and Proxy Statement,” or a “Notice of Special Meeting of Stockholders.”

Circular letters are used to communicate the same message to a large number of customers and suppliers. If they are written in an attractive style and in an interesting manner it will be effective for business communication.

When a business-man wants to give publicity to a cause or a campaign they go for circular letters. Through such letters the readers are provided with facts and figures about the firm. The circular letters aim to create the interest in the contents and thereby win the confidence of the readers.

Circular letters are normally used when opening of a new branch, change of premises, introduce a new article, reduction of sales, admission, retirement and death of a partner and change in the constitu­tion of the firm.

While drafting a circular the following points should be kept in mind:

• The circular letter must be drafted carefully.
• They must be informative.
• They must not be ambiguous.
• The circulars must be courteous in tone and pleasing in form.
• While drafting a circular letter the purpose of the same should be kept in mind.
• The circular letter must be concise.

Purposes:

The circular letters are issued for many purposes.

Generally, a circular letter conveys the following types of information:

• Establishment or transfer of a business.
• Opening of a new branch.
• Change of premises.
• Taking over a business or closing down a business.
• Dissolution or amalgamation of business.
• Appointment, discharge or retirement of an important employee.
• Admission or death of a partner.
• Issue of bonus shares.
• Offer of right shares to shareholders.

A debt security is an investment in bonds issued by the government or a corporation. At the time of purchasing a bond, the acquisition costs are recorded in an asset account, such as “Debt Investments.” Acquisition costs include the market price paid for the bond and any investment fees or broker’s commissions. For example, if Computers Galore purchases five of the 10%, ten‐year Rs. 1,000 bonds issued by VEI on April 1 for Rs. 5,500 and pays broker’s fees of Rs. 50, the entry to record the purchases would include both the purchase price and broker’s fees in the cost of the investment.

Preferred stock is a type of stock that usually pays a fixed dividend prior to any distributions to the holders of the issuer’s common stock. This payment is typically cumulative, so any delayed prior payments must be paid to the preferred stockholders before distributions can be made to the holders of common stock. However, the holders of preferred stock usually gain this advantage in exchange for giving up their right to share in any additional earnings generated by the company, which limits the amount by which the shares can appreciate in value over time.

Preferred Stock Characteristics

In the event of liquidation, the holders of preferred stock must be paid off before common stock holders, but after secured debt holders. Preferred stock holders can have a broad range of voting rights, ranging from none to having control over the eventual disposition of the entity.

Preferred stock dividends may be stated as a fixed amount (such as $5) or as a percentage of the stated price of the preferred stock. For example, a 10% dividend on $80 preferred stock is an $8 dividend. However, if the preferred stock trades on the open market, then the market price will fluctuate, resulting in a different dividend percentage. For example, the investment community believes that a 10% dividend on a stated share price of $80 is higher than the market rate, so it bids up the price of the stock, so that an investor pays $100 per share. This means that the actual dividend on the preferred stock is still $8, but it has now declined to 8% of the amount paid by the investor. Conversely, if the investment community believes that the dividend is too low, then it bids down the price of the preferred stock, thereby effectively increasing the rate of return for new investors.

Preferred Stock Features

Unlike common stock, there are several features that can be added to preferred stock to either increase its attractiveness to investors or make it easier for the issuing company to buy back. You may elect to use just one of the following features, or several at once in order to achieve the company’s goals and meet the needs of investors:

Callable. This feature gives a company the ability to buy back preferred stock on specific dates and at predetermined prices. This feature is useful for those companies anticipating that they can secure lower-interest financing elsewhere in the near future. It is opposed by the buyers of preferred stock, who do not want to sell back their shares and then have to presumably use the funds to obtain lower-return investments elsewhere.

Convertible. This feature gives investors the option to convert their preferred stock into a predetermined number of shares of the company’s common stock at some point in the future. The conversion feature is initially set at a conversion ratio that is not attractive to investors at the point of purchase. However, if the price of the common stock increases, then investors can convert to common stock, and may then sell the stock to realize an immediate gain. For example, an investor pays $100 for a share of preferred stock that converts to four shares of the company’s common stock. The common stock initially sells for $25 per share, so an investor would earn no profit by converting. However, it later increases to $35 per share, so an investor would be inclined to convert to common stock and sell his four shares of common stock for a total of $140, thereby reaping a profit of $40 per share of preferred stock purchased. This is considered a valuable feature if there is an expectation that a company’s value will increase over time.

Cumulative. If the company is unable to pay dividends to its preferred shareholders, then these dividends are said to be “in arrears,” and the cumulative feature forces the company to pay them the full amount of all unpaid dividends before it can pay dividends to its common shareholders. This is a common feature of preferred stock.

Participative. Investors may want the ability to participate in whatever additional company earnings are left after their preferred dividends have been paid. This feature can cut deeply into the earnings available to common stockholders, and so is opposed by them. The participative feature is usually only granted by companies that have no other means of raising capital.

Example of the Accounting for Preferred Stock

Davidson Motors sells 10,000 shares of its Series A preferred stock, which has a par value of $100 and pays a 7% dividend. The investment community believes that the dividend rate is somewhat above the current market rate on similar investments, so it bids the price of the stock up to $105 per share. Davidson Motors records the share issuance with the following entry:

In June 2018, the Indian government notified the Companies (Significant Beneficial Ownership) Rules, 2018 (the “SBO Rules”) imposing reporting obligations on individuals having significant beneficial ownership in companies However, the SBO Rules did not provide a great deal of clarity on the nature and extent of disclosure, and therefore, the reporting obligation was put on hold.

Pursuant to consultations with various stakeholders, the Indian government has notified the Companies (Significant Beneficial Ownership) Amendment Rules, 2019 the (“SBO Amendment Rules”).  Now, a “significant beneficial owner” will mean any individual (acting alone or together or through one (1) or more persons or a trust) who possesses one (1) or more of the following rights in an Indian company (the “Reporting Company”):

• Holds indirectly, or along with any direct holdings, at least 10% of the shares;
• Holds indirectly, or along with any direct holdings, at least 10% of the voting rights in the shares;
• Holds indirectly, or along with any direct holdings, the right to receive at least 10% of the total distributable dividend or any other distribution in a financial year; or
• Has the right to exercise or actually exercises significant influence or control other than by virtue of his or her direct shareholding. For this purpose, “significant influence” has been defined as the power to participate in the financial and operating policy decisions of the reporting company.

In respect of the foregoing rights, the SBO Amendment Rules clarify that an individual cannot be considered as a significant beneficial owner if he or she holds the above-mentioned rights or entitlements directly.  Further, the SBO Amendment Rules define the term “indirectly” in respect of each possible category of member of a Reporting Company apart from an individual.  For instance, if the member is a body corporate, the individual must hold either a majority stake in that body corporate or a majority stake in the ultimate holding company of such body corporate.  For this purpose, a “majority stake” will mean holding:

• More than 50% of the equity share capital of the body corporate;
• More than 50% of the voting rights in the body corporate; or
• The right to receive more than 50% of the distributable dividend or any other distribution by the body corporate.

The deadline for significant beneficial owners to report significant beneficial ownership interest to their respective Reporting Companies under Form No. BEN-1 has been set as May 9, 2019.  This reporting obligation is not applicable, among others, to alternate investment funds, real estate investment funds and government owned entities or local authorities.  Upon receipt of the disclosure, the Reporting Company will have to comply with obligations of maintaining registers and filing returns as per the SBO Rules.

In our view, the SBO Amendment Rules provide much needed clarity on the meaning of significant beneficial ownership, enabling such owners and Reporting Companies to identify whether their interest is required to be reported. Moreover, while the compliance burden still remains, the streamlining of the definition of indirect holdings has exempted a large number of individuals who were previously considered to be included under the purview of the SBO Rules.

Verification of registered office address

The Indian government has introduced a reporting requirement for verification of the details of the registered office of an Indian company.  Pursuant to the new requirement, all companies incorporated on or before December 31, 2017 will be required to file Form INC-22A on or before April 25, 2019 and provide the following:

• Latitude and longitude of the registered office address;
• Photograph of the registered office showing the inside and outside of the building;
• Photograph of at least one (1) director or key managerial personnel, who will affix his or her signature on the form, while such director or key managerial personnel is inside the registered office;
• E-mail address of the company; and
• Details of the current statutory auditors, cost auditors, company secretary, chief financial officer and directors of the company.

This requirement will not apply to companies which:

(i) Have been struck off from the register of companies

(ii) Are in the process of being struck off

(iii) Are under liquidation

(iv) Have been amalgamated or dissolved.

If a company fails to file Form INC-22A before the due date, it will not be permitted to file various other e-forms mandatorily required under the Act until Form INC-22A has been duly filed along with a penalty of INR10,000 (Indian Rupees Ten Thousand).

The objective behind introducting this reporting requirement is to ensure that companies maintain active and operational registered offices.  In our view, this reporting requirement is unlikely to achieve this objective, as practically speaking, there is no way for the authorities to verify whether the address provided by a company actually continues to function as the registered office over a period of time.  Moreover, the requirement for providing photographs of the director and the office building appear to be unnecessary and cumbersome.

Reporting for dealings with MSEs

In November 2018, the Indian government had directed all companies who receive goods or services from MSEs (which are defined based on capital investments and turnover thresholds) and have delayed payments to such MSEs beyond forty-five (45) days from the date of acceptance of such goods or services to file a half-yearly return disclosing the details of such pending dues.

Now, the Indian government has directed all companies to provide details of amounts due to MSEs beyond forty-five (45) days as on January 22, 2019 in MSME Form 1 along with reasons for the delay in payment.  This reporting will have to be made within thirty (30) days of the date on which the Indian government notifies MSME Form 1, which is pending to be notified as on date.

Moreover, companies will also be required to file details of pending dues by October 31 of each year in respect of dues outstanding during the period from April to September and by April 31 for the period from October to March.

This reporting requirement has been introduced to ensure that MSEs, which do not have access to a large amount of capital, receive payment for their goods and services in a timely manner.  However, in our view, the requirement for filing the return every six (6) months will increase the compliance burden on companies.

Debenture is a long-term financial instrument that represents a loan made by an investor to a borrower, typically a corporate entity. It is issued under a formal agreement, which stipulates the terms of the loan, including the interest rate, repayment schedule, and the rights and obligations of both the issuer and the debenture holder.

Debentures are usually Secured or Unsecured:

• Secured Debentures:

These are backed by specific assets of the company, providing assurance to debenture holders that they can claim these assets in the event of default.

• Unsecured Debentures:

These are not backed by any specific assets, making them riskier for investors.

Importance of Debentures in Subsidiary Companies:

Subsidiary companies are entities that are controlled by a parent company, typically holding a majority of shares.

1. Capital Raising

Subsidiary companies often require funds for various purposes, such as expansion, acquisition of assets, or working capital. Issuing debentures provides a means of raising capital without diluting the ownership of the parent company. This is particularly advantageous for subsidiaries that may not have easy access to equity markets.

2. Fixed Cost of Financing

Debentures typically carry a fixed interest rate, which allows subsidiary companies to predict their financing costs accurately. This predictability aids in financial planning and budgeting, enabling the subsidiary to manage its cash flows effectively.

3. Flexibility in Financing

Debentures offer flexibility regarding maturity periods and repayment schedules. Subsidiary companies can structure their debenture issues to align with their cash flow needs, allowing for better financial management.

4. Tax Benefits

Interest payments on debentures are tax-deductible, which can enhance the financial efficiency of subsidiary companies. This tax advantage makes debt financing more attractive compared to equity financing.

5. Attraction of Diverse Investors

Issuing debentures can attract a wide range of investors, including institutional investors who prefer fixed-income securities. This diversification of the investor base can enhance the subsidiary’s financial stability and reputation in the market.

Regulatory Framework Governing Debentures in Subsidiary Companies:

In India, the issuance and management of debentures by subsidiary companies are regulated under the Companies Act, 2013, as well as the Securities and Exchange Board of India (SEBI) regulations. Key provisions are:

1. Issuance of Debentures

Section 71 of the Companies Act governs the issue of debentures, stipulating that a company may issue debentures subject to the conditions specified in the act. Companies must pass a resolution to approve the issue of debentures, which may require obtaining consent from the shareholders in certain cases.

2. Debenture Trust Deed

Debenture trust deed is a legal document that outlines the terms and conditions of the debenture issue, including the rights of debenture holders and the obligations of the issuing company. It must be executed in favor of a trustee representing the debenture holders to safeguard their interests.

3. Redemption of Debentures

Companies are required to outline a clear redemption plan for debentures in their issuance documents, specifying the maturity period and repayment terms. Provisions for the creation of a debenture redemption reserve may also apply, which is a fund set aside for the repayment of debentures upon maturity.

4. Interest Payments

Subsidiary companies must ensure timely payment of interest to debenture holders as stipulated in the debenture agreement. Failure to do so can lead to legal consequences and impact the company’s creditworthiness.

5. Filing Requirements

Subsidiary companies must comply with filing requirements under the Companies Act, including submitting necessary forms to the Registrar of Companies (ROC) concerning the issuance of debentures.

6. Regulations by SEBI

If the debentures are listed on stock exchanges, the subsidiary company must also comply with SEBI regulations, which impose additional disclosure and reporting requirements to protect investors’ interests.

Types of Debentures Suitable for Subsidiary Companies:

1. Convertible Debentures

These debentures give holders the right to convert their debentures into equity shares of the company after a specified period. This option can be attractive to investors, as it allows them to participate in the company’s equity upside.

2. Non-Convertible Debentures

These debentures cannot be converted into equity shares and typically offer higher interest rates compared to convertible debentures, compensating investors for the lack of conversion rights.

3. Redeemable Debentures

These debentures are issued with a specified maturity date, at which point the company must repay the principal amount to the debenture holders. This type allows for better cash flow management.

4. Irredeemable Debentures

Irredeemable debentures do not have a fixed redemption date and may remain outstanding indefinitely. They can provide a steady income stream for the issuing subsidiary but may be less attractive to investors due to their uncertain repayment timeline.

(a) Increase in share capital: A company can increase its share capital by issue of new shares by an ordinary resolution in the general meeting if the increase is within the authorised capital. But for increase beyond the authorised capital, the company is required to alter the capital clause of its Memorandum of Association by special resolution and to give its notice to the Registrar within 30 days of resolution.

No accounting entry is required to be passed in the books of the company for the increase in its authorized share capital. But when new shares are offered for subscription, accounting entries will be very much the same as has been explained in an earlier chapter.

(b) Decrease in share capital by cancelling the unissued shares: A company can cancel the shares which have not been subscribed or agreed to be subscribed by any person and this diminishes the amount of share capital. But no company can cancel the unpaid amount on shares already issued or agreed to be subscribed without the sanction of the Court as the same leads to reduction of capital. As the cancellation of unissued shares does not affect the issued share capital of a company, no accounting entry is required. Only the details of authorized share capital are to be changed in the Balance Sheet

(c) Consolidation of share capital: A company may consolidate any of its shares of smaller denomination (value) into shares of higher denomination. To make this change effective, share capital account with old denomination is closed and share capital account with new denomination is created. The accounting entry is:

Share Capital (Old denomination) Account                                Dr.

To Share Capital (New denomination) Account

(d) Sub-division of share capital: This implies converting shares of higher denomination into shares of smaller denomination. The entry is:

Share Capital (Old denomination) Account                                 Dr.

To Share Capital (New denomination) Account

(e) Conversion of shares into stock and reconversion of stock into shares: A company, if so authorised by its Articles, may convert any of its, fully paid shares into stock. The stock can be reconverted into fully paid up shares of any denomination. When shares are converted into stock, the share capital account will be closed by transfer to stock account by means of the following journal entry:

(Say) Equity Share Capital Account                                           Dr.

To Equity Stock Account

Conversely if stocks are reconverted into shares, stock account will be closed by transfer to share capital account.

(f) Reserve Capital: Section 99 of Companies Act provides that a company may by special resolution decide that any portion of uncalled amount on shares issued will be called up only on its liquidation. Such portion of share capital is known as reserve capital. No accounting entry is required to give effect to it.

(2) Reduction of Share Capital: Usually internal reconstruction involves reduction of share capital. Section 100 to 105 of Companies Act deal with it. Accordingly, it can be carried out by a company only It is authorised by its Articles, and a special resolution is passed to that effect. It also requires confirmation of the Court.

Capital reduction can take any of the following three forms:

• Extinguishing or reducing the liability on shares held by shareholders in respect of uncalled or unpaid amount : This does not affect the paid-up value of shares; only partly paid shares become fully paid by reducing the face value of the shares to the level of their paid-up value. No journal entry is necessary to record this event. However, some accountants prefer to pass the following entry to record this fact:

Share Capital (partly paid-up) Account                      Dr

To Share Capital (fully paid-up) Account

• Paying off the surplus paid-up capital: The share capital may be reduced by paying off the paid-up capital which is in excess of the needs of the company. This can be done with or without reducing the liability on the shares. Thus, surplus capital can be paid off in the following two ways: (a) Paying off surplus paid-up capital without reducing the face value of shares: In such a case, the following entries are passed:

(i) Share Capital Account                               Dr.                 with the amount to be paid off

To Sundry Shareholders Account

(ii) Sundry Shareholders Account                  Dr.                  with the amount paid off

To Bank Account In this case, the company shall have the right to call up in future the amount paid off on the shares.

(b) Paying off surplus paid-up capital by reducing the face value of shares: For example, for a fully paid share of Rs. 10, paying off Rs. 5 and reducing the face value of share from Rs. 10 to Rs. 5. The following entries are passed in such a case. () Share Capital (Old Face Value) Account Dr. (with total amount of old capital) To Share Capital (New Face Value) Account (with the amount to be kept as new capital)

To Sundry Shareholders Account                   Dr             (with amount to be paid oft)

(ii) Sundry Shareholders Account                  Dr. with the amount paid off To Bank Account

In this case, the company shall not have any right to call up in future the amount paid off on these shares.

(c) Cancelling the paid-up capital: Where existing capital of the company is not represented by available assets, cancellation of paid-up capital to that extent is the most common method adopted by a company in such a case. The purpose is to improve the profitability of the existing company in tune with the real values of assets as against the given book values which do not represent the actual financial position of the enterprise. Under it, a meeting of different classes of shareholders is called-up and where borrowed capital is also lost, the debenture holders and creditors are also invited in the meeting and they are made to agree to sacrifice their claims to certain extent and their sacrifices are utilized to write off the accumulated losses and fictitious assets and to adjust the over-valuation of assets. For this purpose, a new according called Capital Reduction Account (or Reconstruction Account or Reorganisation Account) is opened to which sacrifices of different parties are credited and through which accumulated losses and fictitious assets are written off and over-valuations of assets adjusted. The preparation of Reconstruction Account is preferred when debenture holders and creditors too have to accept some reduction in their claims in addition to the shareholders and/or where there is appreciation in the value of any asset. The scheme of entries is as follows:

• On reduction of paid-up capital:

Share Capital Account                                  Dr. with the amount of reduction

To Capital Reduction Account                      or To Reconstruction Account

If the denomination or description of capital is changed (e.g. the face value of shares is changed or rate of dividend is changed in case of preference shares), the old Capital Account is closed and new capital account is created with the new amount and the difference is transferred to Capital Reduction Account

Notes: (i) If any reserve appears in the books of the company, the same should be transferred to Capital Reduction Account so that no such reserve could be utilized for payment of dividend in future.

(ii) The Capital Redemption Reserve Account and Securities Premium Account can also be reduced in the same manner as the share capital account.

(iii) After granting the scheme of capital reduction, the Court may order the use of words “and reduced” after the name of the company for such period as it deems fit.

• If debenture holders and creditors too make some sacrifice:

Debentures Account                  with the amount of sacrifice Sundry Creditors Account

To Capital Reduction Account

3. If there is appreciation in the value of an asset:

Respective Asset Account                                Dr. with the amount of appreciation

To Capital Reduction Account

4. On utilizing Capital Reduction Account for writing off accumulated losses, fictitious assets, and over-valuations of assets:

Capital Reduction Account                                  Dr

To Profit & Loss Account

To Goodwill Account

To Patent Account

To Trade Marks Account

To Preliminary Expenses Account

To Discount on Shares and Debentures Account

To Unrecorded Liability Account (if any) To Asset Account

To Capital Reserve Account (with the balance left, if any)