In this article, Shubham Prakash discusses, how to convert Compulsorily Debentures into equity shares. What is the procedure to be followed with respect to RoC and the Internal Process?

Introduction

‘Debenture’ is a debt instrument used by the companies for a long period of time in order to borrow money at the fixed rate of interest. Section 2(30) of The Companies Act, 2013 defines debentures “includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not”. Also Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 and Section 71 of the Companies Act, 2013 talks about debentures. It is like a certificate loan where the company is liable to pay the loan at a fixed rate of interest. The capital raised by the debentures would not become the share capital instead becomes the company’s capital structure. On basis of convertibility there are two types of debentures:

  • Convertible debentures – When a company is issued, these debentures are converted into equity shares at the expiry of a fixed period of time.
  • No – convertible debentures – They are regular debentures which cannot be converted into equity shares because of a higher rate of interest.

Equity share is issued to the general public at large and the main function is to provide finance to the company. The equity shareholder does not have any preferential rights but they have to repay the capital and dividend. They are the real owner of the company and have the voting right when the meetings are conducted. Section 43 (a) of the Companies Act, 2013 talks about equity share capital as:

  • With voting rights; or
  • With differential rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed

What is a convertible debenture?

A convertible debenture is defined as one of the types of loan which is issued by a company that can be converted into a stock. Most of the people get confused between convertible bonds and convertible debentures. But a convertible debenture is unsecured when there is a case of bankruptcy. The debenture of the company gets money from the fixed- income holders. The basic feature of convertible debentures is to calculate the diluted per- share standard. The diluted per- share standard goes up with the increase of share count and it goes down with the decrease in metrics such as earning per share (EPS).

In Compulsorily convertible debenture the cost of the debenture is converted into an equity share within a fixed period of time. It is also known as CCD. CCD is not a combination of pure debt or pure equity. During the issuance of the company, the CCD decides at which rate the ratio of conversion will be there from debentures to equity share capital.

Conversion Of Compulsorily Convertible Debentures Into Equity Shares

Section 71(1) of the Companies Act, 2013 authorizes the company to issue debentures with an option of to convert such debenture into shares, either wholly or partly at the time of redemption, provided that it shall be approved by a special resolution of passed at the general meeting. The issuance of a compulsorily convertible debenture is through a placement offer made by the company privately.

When there is a conversion of CCD into equity shares, there is no debenture redemption reserve is required. The CCD at the time of conversion of equity share can neither issue any trust deed nor appoint any debenture trustee for securing the payment at time of maturity.

As per the Companies (Acceptance of Deposits) Rules, 2014 which does not include clause xi of Rule 2 (1) (c) can raise the amount of issuance of debentures as referred in Schedule III of the Act which also not include the insubstantial assets of the debentures compulsorily convertible into a equity share capital of the company within a period of 10 years. So it is compulsory for the compulsorily convertible debenture into an equity share capital within a period of 10 years otherwise it will be viewed as deposit under the Companies Act, 2013 and the provision of ‘deposit’ will be taken into consideration. With the amendment made in the year 2016, the time period has increased from 5 years to 10 years.

As per the guideline issued by the Reserve Bank of India, the compulsorily convertible debentures are considered as equity shares under a financial statement. However until and unless the compulsorily convertible debentures are not converted into equity share, it would be considered as share capital of the company.

Cases

The Indian Judiciary has discussed the conversion of compulsorily convertible debentures into equity shares in many cases

In Ashima Syntex v. Assistant Commissioner of Income Tax,[1] the court held that fully convertible debentures expenses should not be paid. The convertible debentures should be added to the equity capital of the company on conversion of shares. The reason for not paying the expenses is because convertible debentures issued by the assessee were to be fully converted into equity shares on allotment or after a certain period and this money received by the assessee in the form of application money was never to be repaid to the subscribers thereof. The money becomes the part of the funds of the company in form of equity and company gains an advantage.

In CIT v. Moto Industries Co. Ltd., ILR 1992 Karnataka 345- the court held that “the debentures are issued or subscribed to acknowledge the debt owed by the financial institution from which the loans were obtained and the amounts were utilized”.

In Deputy Commissioner of Income Tax v. Modern Syntex (India) Ltd., (2005) 95 TTJ (JP) 161- the tribunal held that the “expenditure incurred was on ‘issue of debentures in other words for raising of loan’ and the debentures were ‘issued by the company and it is in form of certain indebtedness’. This was irrespective of the fact that these debentures were convertible into equity shares.”

In Ganesh Banzoplast Limited v. Assistant Commissioner of Income Tax,[2] the court held that “debentures, convertible or non- convertible is acknowledged of indebtedness”.

However in Sahara Real Estate Corporations Limited v. SEBI,[3] Supreme Court has scrutinized the hybrid instruments taking into a contrary view that convertible debentures are for the security purpose of the Act. The Court held that “it is clear, that ‘hybrids’ are included within the terms of ‘securities’ not only for the purpose of Companies Act but also, under the SEBI Act”.

The same judgment was applied in the case of Income Tax Appellate Tribunal, Delhi (“ITAT”) in DCIT v. Sahara India Commercial Limited,[4] where ITAT clearly distinguishes between the ‘securities’ on one hand and ‘loans’ on the other hand. It was held that “optional convertible debentures are ‘securities’ and mot ‘loans’ or ‘deposit’ for the purpose of the Income Tax Act, 1961”.

In Zaheer Mauritius v. Director of Income Tax,[5] that while converting the Compulsorily Convertible Debentures (CCDs) into equity shares the petitioner is not exempted from income tax. The entire sale of equity shares and Compulsorily Convertible Debentures (CCDs) needs to be taxed. It was held that “there was sufficient commercial reason for Petitioner to have routed its investment in real estate project through equity and CCDs”.

In Narendra Kumar Maheshwari v. Union of India & Ors.[6], the issue before the court was whether in certain brochures and pamphlets issued by a company are described as “fully secured convertible debentures” or not. The court held that the printed brochures use those words without intending to change anything. But the consent of the company is required for adding “fully secured convertible debentures” in brochures and pamphlets.

Procedure For Conversion Of Compulsorily Debentures Into Equity Share

In order to convert compulsorily convertible debentures into equity shares, the issuer of the company cannot do so because it is the holder of the company who has to send a positive consent to the issuer. If the issuer does not reply for the same, that would not be considered as a consent for the conversion of compulsorily convertible debentures into equity shares.

If the issuer lists the convertible debt instruments by more than fifty lakh rupees, then the issuer has not converted the convertible debt instrument correctly. The holder of such convertible debt instruments will be given the option whether he or she wants to convert the compulsorily convertible debentures into equity shares. Provided that the compulsorily convertible debentures are limited and is determined and disclosed to the investors at the time of issuance. Sometimes it is not compulsory or mandatory to give an option to the holder of the convertible debt instruments for converting the compulsorily convertible debentures into equity shares with an upper limit.

According to the Companies Act, 2013 the option is given to the holder in terms of sub-regulations (2). In general, meetings if one or more shareholders do not enjoy the option to convert the compulsorily convertible debentures into equity shares at a fixed price. Then, the issuer can redeem the price which shall not be less than its face value, within one month from the last date by which option is exercised.

Procedure

  • It is important to hold a board meeting and pass a board resolution.
  • When a general meeting is conducted the member should pass a special resolution. The company cannot make a preferential basis on the issuance of the shares until and unless it is mentioned in the Article of Association and is passed by the members in general meeting.
  • According to Section 62 of the Companies Act, 2013 it is mandatory to prepare an explanatory statement for the special resolution. The statement should contain the important matters
  • It is important to file a special resolution with Registrar of companies (ROC) within 30 days in form of MGT- 14.
  • A letter of an option of the same is sent to the compulsorily convertible debentures holders and one copy is sent to Securities and Exchange Board of India (SEBI). It is the duty of the secretary to verify same consent sent by the debentures holders for the conversion.
  • When the final valuation report is received there is an allotment of shares. The allotment of a share should be completed within 12 months from the date of passing of the special resolution. The price of the share is determined based on the valuation report.
  • As per Form SH-1, it is mandatory to prepare and issue share certificate.
  • The share certificate is issued to holders and the names are entered in the Register of Members.
  • Within 30 days of allotment of Form PAS-3, a return allotment of securities should be filed with the Registrar. The fee should be given according to the Companies (Registration Offices and Fees) Rules, 2014 along with the list of complete holders.
  • The list of paper required in for the return of allotment of PAS-3 is a list of allottees, a copy of the board of resolution, a copy of the special resolution and valuation report.

Hence, compulsorily convertible debentures are converted into equity shares.

References

[1] https://indiankanoon.org/doc/121400/

[2] (2007) 111 TTJ (Mum) 385

[3] (2013) 1 SCC (Civ) 1

[4] 2013 (28) ITR (Trib) 108 (Delhi)

[5] (2014) 270 CTR (Del) 244

[6] https://indiankanoon.org/doc/65796/

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