Aniruddha JainRecently, well known auto manufacturer announced the issuance of preference shares as a bonus to all equity shareholders. In the past, many listed companies have issued preference shares as a bonus. In this article, we will try to analyze the different facets of issuing preference shares as a bonus.
TVS Motor Company Limited (“TVS” or “Company”) is engaged in manufacturing two & three wheeler vehicles. The Company has state of art manufacturing facilities in Hosur, Mysuru and Nalagarh in India and Karawang in Indonesia. The equity shares of the company are listed on nationwide bourses.
The Proposed Transaction
The Board of Directors of the Company at its meeting inter alia, has approved the Scheme of Arrangement between the Company and its shareholders under Sections 230 to 232 of the Companies Act, 2013 (“Scheme”), which, inter-alia, provides for issuance and allotment of cumulative non-convertible redeemable preference shares by way of bonus.
Bonus Ratio:
4 NCRPS (Cumulative non-convertible Preference Share) of INR 10/- each fully paid up of the Company for every 1 equity share of INR 1 each fully paid up held as on the Record Date
The dividend rate will be 6% per annum.
The NCRPS shall be redeemed on the expiry of 12 months from the date of allotment of the said NCRPS
Proposed to be listed on the NSE (National Stock Exchange of India) Limited and BSE (Bombay Stock Exchange) Limited i.e., the stock exchanges on which the equity shares of the Company are listed.
Rationale for issuance of bonus shares:
- The company has built up substantial reserves over the years from its retained profit which is well above the company’s current and likely business needs.
- Accordingly, the company proposes to distribute surplus funds amongst shareholders.
Total Bonus outlay by the company:
| Particulars | Amount |
| Total paid-up number of equity shares of INR 1 each | 47,50,87,114 |
| Total No. of Preference Shares of INR 10 each to be issued as bonus | 190,03,48,456 |
| Total outflow (excluding 6% dividend) | 1900,34,84,560 |
The current free reserves as on 31st December 2023 of the company is circa INR 7574 crore.
Direct Tax
As per section 2(22)(a) of the Income Tax Act, 1961:
Dividend also includes:
“Any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company”
Thus, issue of preference shares as a bonus shall be treated as dividend in the hands of shareholders. As on 31st December 2023, the free reserves (accumulated profits) of the company were circa INR 7574 crores. Thus, the entire issue of bonus shares is through accumulated profits.
As envisaged in the scheme, the issue of a bonus to equity shareholders does not involve any release of assets by the company to shareholders at time of issuance of preference shares by way of bonus. This was specifically mentioned to defer any tax liability at the time of issuing preference shares to shareholders. The key questions which one needs to ponder will be:
- Taxability if sold through the market before redemption.
- Taxability at the time of redemption
Even treatment can be argued differently as one may consider selling through the market before redemption as capital gains and not dividend.
Analysis:
Accounting Treatment
Like accounting for any bonus shares or payment of dividend, the Company shall credit its share capital account to the extent of the face value of preference shares issued. The equivalent amount shall be debited to general reserve/retained earnings.
Foreign Exchange Management Act
In 2019, the Foreign Exchange Management Act regulations were relaxed and allowed issue of non-convertible preference shares through the National Company Law Tribunal approved scheme. As a result, non-redeemable preference shares can also be issued to non-resident shareholders.
One of the reasons for the issuance of bonus shares, through the scheme is an amendment in FEMA regulations. Earlier practice was to incorporate a special trust for holding shares to be issued to nonresident Indians and making payment post liquidation of the same by the trust.
Others
In the past, many of the listed companies have issued either preference share or debentures as bonus shares to equity shareholders. Instead of dividends, these instruments are mainly used to reward shareholders but defer immediate cash outflows. One may argue that the taxability may change if sold before redemption.
To issue preference shares of debenture, the company needs to get approval from the National Company Law Tribunal. Further, the financial & tax impact of interest vs dividend payable on debenture & preference share respectively is different.
TVS Holdings Limited
TVS Holdings Limited is the holding company of TVS, holding 50.26% of the total paid-up equity capital of TVS. Interestingly, two years before a similar transaction was carried out by TVS Holdings Limited by issuing 9% cumulative non-redeemable preference shares as a bonus to its equity shareholders.
In March 2024, TVS Holdings Limited redeemed all the preference shares. Out of the current issue, preference shares worth INR 954 crore will be received by TVS Holdings Limited. After demerging the Aluminum die-casting business last year, currently, TVS Holdings Limited seems to be expanding its real estate business. Further, recently it also acquired 80.74% equity stake in a consumer finance business of INR 554 crore. The bonus preference shares issued to it will increase its asset base & net worth immediately after the issue of preference shares, but taxability will be deferred till redemption/transfer.
TVS Holdings may also evaluate transferring the amount to its shareholders as a dividend (likely to be tax-neutral to TVS Holdings on account of provisions of Section 80M of the Income Tax Act, 1961) or use the proceeds to settle any of the intercompany dues pursuant to the family arrangement entered in 2022. The funds could also be utilized for growing its real estate business or NBFC (Non-Banking Finance Company)/ fund recent acquisitions which may amount to different verticals in coming years.
Conclusion
Issuance of preference shares/debentures as a bonus is akin to the dividend but has different aspects while determining over the simple dividend. The reason for the issuance of bonus preference shares by TVS could be after considering the various aspects, mainly the expansion of its holding company & family arrangement entered in past. For minority investors, this can be well planned to maximize the net inflows to them.
