Redemption of debentures means the amount of repayment to the debenture holders of the debt due to them. The debentures are usually repaid after the expiry of certain time period. When debentures are redeemed, liability on account of debentures is discharged. Amount of funds required for redemption of debentures is quite large and therefore prudent companies make sufficient provisions out of profits and accumulate funds to redeem debentures.
PROVISIONS/ CONDITIONS FOR REDEMPTION OF DEBENTURES
The Companies Act 2013 regulates the Redemption of Debentures. The following are the provisions or conditions related to the redemption of debentures as per the Section 71(4) of Companies Act 2013 and Rule 18(7) of the Companies Rules, 2014:
CREATION OF DEBENTURE REDEMPTION RESERVE
Debenture redemption reserve is the reserve created especially for the purpose of redemption of the debentures. It is created as per the provisions of Section 71(4). The following are the provisions related to the redemption of debentures:
- DRR is created out of the surplus i.e. the balance of Statement of profit and loss.
- It is created atleast equal to the 25% of the total face value of the debentures to be redeemed.
- The DRR is created equal to the 100% in case redemption is made out of the Profit.
INVESTMENT IN SPECIFIED SECURITIES BY 30TH APRIL
The rule 18 (7)(c) of the Companies Rules, 2014 states that every company must invest the amount of DRR in the specified securities. The following are the provisions related to this:
- Investment is made atleast equal to the 15% of the face value of the debentures to be redeemed.
- The investment is made before the date of 1st April of the year at the end of which the debentures are to redeemed.
- The amount invested in the securities must be used only for the purpose of redemption of debentures.
ENCASHMENT OF INVESTMENT IN SPECIFIED SECURITIES
The company should encash the investment in specified securities before the redemption of debentures.
USE OF DRR
The Debenture Redemption reserve will not be utilized by the company for any other purpose except for redemption of debentures.
OBLIGATION TO CREATE DRR
The creation of DRR is obligatory in the case of:
- Non-convertible debentures
- Non-convertible portion of partly convertible debentures.
COMPANIES EXEMPTED FROM CREATING DRR
As per the Rule 18(7) of the Companies Rules, 2014 the following companies are exempted from the creation of DRR:
- All India Financial Institutions regulated by RBI.
- Banking Companies.
METHODS OF REDEMPTION OF DEBENTURES
There are three ways of redemption of debentures which are as follows:
REDEMPTION AFTER STIPULATED TIME PERIOD
The debentures are redeemed after the fixed period of time. At the time of the issue of the debentures, the debenture certificate is issued to the debenture holders. The date of the redemption of the debentures is mentioned on the debenture certificate. Thus, the company knows in advance the date of redemption of the debentures, so it is easy for the company to make arrangement for the funds. The date of redemption of debentures is known as the maturity date.
REDEMPTION BY ANNUAL DRAWINGS
The debentures are also redeemed in installments. The company repay the amount due on the debentures in installments. Thus at the end of the life period of debentures, the full amount is repaid over them.
In case of redemption of debentures by annual drawings, drawing by lots technique is used. In this system, the slips containing the distinctive number of debentures are put into a box. The required numbers of slips are put out of the box. The slips selected are the debentures that are to be redeemed by annual drawings.
The amount of debentures to be redeemed are calculated as follows:
Total number of debentures/ No. of years.
The amount calculated is equal in all installments. However it may be unequal also.
REDEMPTION BY PURCHASE OF DEBENTURES IN THE OPEN MARKET
The company can also redeem its debentures by purchasing them from the open market. The company do so only if it seems convenient and profitable to it. Purchase of debentures by this method will reduce the liabilities of the company against the debentures. Reduction of debentures will also mean its cancellation and virtually redemption. Own debentures may also be purchased by the company for its own investment and same may be reissued in future also. This method leads to following gains for the company:
- There would be immediate saving of an equal amount to difference of par value and purchase price of the debenture.
- There would be a future saving of the amount of any premium which was promised at the date on which they were to redeem.
- There would be a saving of annual interest payable on the debentures in future i.e. the interest which would be payable if the debentures had not been purchased in the open market.