INTERNAL RECONSTRUCTION

MEANING

Internal Reconstruction is also known as Capital Reduction. Section 66 of the companies Act governs the internal reconstruction. A company resorts to internal reconstruction or capital reduction only in exceptional circumstances. Internal reconstruction result in the reduction of the capital of the company.

CONDITIONS/ PROVISIONS REGARDING INTERNAL RECONSTRUCTION

AUTHORISATION BY ARTICLES OF ASSOCIATION

The company must be authorized by its articles of association to resort for capital reduction. Articles of association contains all the details regarding the internal affairs of the company and mention the clause containing manner of reduction of capital.

PASSING OF SPECIAL RESOLUTION

The company must pass the special resolution before resorting to capital reduction. The special resolution can be passed only if the majority of the stakeholders are assenting to the internal reconstruction. This special resolution must be get signed by the tribunal and deposited to the registrar appointed under the Companies Act, 2013.

PERMISSION OF TRIBUNAL

The company must get the due permission of the court or tribunal before starting the process of the capital reduction. The tribunal grants permission only it feels satisfied with the point that the company is going fair and there is positive consent of every stakeholder.

PAYMENT OF BORROWINGS

As per Section 66 of the Companies Act, 2013, the company has to repay all the amounts it gets deposited and also the interest due thereon before going for capital reduction.

CONSENT OF CREDITORS

The written consent of the creditors is required for the company which is going for capital reduction. The court requires the company to secure the interest of the dissenting creditors. The company gets the permission of the court after the court thinks fit that reduction of capital will not harm the interest of the creditors.

PUBLIC NOTICE

The company has to make a public notice as per the directions of the tribunal stating that the company is resorting to capital reduction. Also the company has to state the valid reasons for the same.    

WAYS OF REDUCTION OF CAPITAL

The company limited by shares and limited by guarantee can go for internal reconstruction in three ways:

By reducing or extinguishing the liability: the company can repay its liability on account of uncalled amount on the shares issued. Under this method, the paid up shares capital of the company would remain unchanged.  In this case, the uncalled liability is cancelled by passing the following entry:

Share capital A/c (Partly paid up)    Dr.

    To Share Capital A/c   (fully paid up)

EXAMPLE: X Limited issued 50,000 equity shares of Rs. 20 each, Rs. 15 called up. After complying with the requirements of the Companies Act, the company proceeds to extinguish the uncalled liability on its shares. The journal entry to be passed is:

Equity share capital A/c (Rs.20) Dr.                          7,50,000

    To equity Share capital A/c (Rs. 15)                                      7,50,000

(Being 50,000 equity shares of Rs. 20 each, Rs. 15 paid converted into equal number of shares of Rs. 15 fully paid up)

Reducing the capital by returning the excess capital: In case the company has availability of surplus cash, the company can use it to repay the excess capital if it finds it profitable. The capital can be refunded after complying with the proper procedure. The journal entry to be passed under this method is as follows:

Share Capital A/c (old)   Dr.

    To share capital A/c (new)

    To shareholders A/c

Shareholders A/c    Dr.

    To Bank A/c

In this method the share capital of the company is reduced upto the amount refunded.

EXAMPLE: A company has 50,000 shares of Rs. 10 each fully paid up. The company decided to repay to its member Rs. 3 per share and make the shares of Rs. 7 each fully paid up. The journal entry will be:

Share Capital A/c (Rs.10)               Dr.                          5,00,000

                To share capital A/c (Rs. 7)                                           3,50,000

                To shareholders A/c                                                       1,50,000

(Being conversion of shares of Rs. 10 into shares of Rs. 7 each money due to its members)

Shareholders A/c                             Dr.          1,50,000

                To Bank Account                                              1,50,000

(Being payment of money to shareholders)

Reducing the paid up share capital: When the company suffers losses continuously due to some reasons, it is quite common that the accumulated losses and deferred expenses will appear on the assets side of balance sheet.  The fictitious assets on the balance sheet makes clear that the company is unable to discharge its liability. Under such circumstances, the capital which is unpresented by available assets should be cancelled. The journal entries to be passed will be:

When the face value of the shares is changed or rate of dividend on preference shares is changed, it amounts to change in the category of the share capital
Share Capital A/c (old)     Dr.
    To share capital A/c (new)
    To capital reduction A/c
If the face value of the shares or rate of dividend is not changed, it does not amount to change in category of share capital.
Share Capital A/c
    To Capital reduction A/c
If debenture holders and other creditors also make sacrifice.
Debentureholders A/c              Dr.
Creditors A/c                              Dr.
      To capital reduction account
If the value of any asset to be appreciated
Asset A/c            Dr.
     To Capital reduction A/c
If some unrecorded/ contingent liability is to be paid for
Capital Reduction A/c            Dr.
    To Liability payable A/c
When the amount of capital reduction is utilized in writing off accumulated losses, fictitious assets, intangible assets etc.
Capital Reduction A/c             Dr.
    To Statement of profit and loss A/c
    To discount/ commission on shares or debentures A/c
    To preliminary expenses A/c
    To goodwill A/c
    To Patents and trade marks A/c
    To other assets A/c
If there is any balance in capital reduction account, the same is transferred in capital reduction account
Capital Reduction A/c        Dr.
     To Capital reserve A/c

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