Section 78 of Companies Act, 1956 – Introduction to Securities Premium Account
The object of Section 78 of the 1956 Act was to lay down specifically how the securities premium accounts collected on the issue of shares should be utilized. The expression “premium” is not defined. It may be that if, over and above the cash payment on the shares, some further advantage measurable in terms of money is conferred on the company the value of such advantage will have to be regarded, as in the nature of a securities premium. A company is not bound to issue shares at a premium. Issue of shares at par even when premium could have been realized cannot be said to have been done at the cost of the company’s capital. A company proposed to issue further shares under section 81 of the 1956 Act and offer them at a securities premium. A preference shareholder filed a suit for a declaration that the company was a public company. The issue raised was placed before the management of the company because of an interim order passed in the suit. The equity shareholder with majority shareholding opposed the proposed issue of shares during pendency of suit. The court found that the valuation of shares was not shown to be artificial or exaggerated. The court said that the equity shareholder could subscribe to such share to maintain its holding. The issue of shares at a premium was not illegal.
Retention of share premium in a separate account
Any share premium collected by a company on issue of shares is required to be retained in a individual account. This amount cannot be utilized for any purpose, other than the ones specified in Sub-section(2) of Section 78 of the 1956 Act. If the amount lying in the securities premium account is used for any other purposes, it would tantamount to reduction in share capital, attracting the provisions of Section 66 of the 1956 Act. Whatever the shares have been issued for cash or otherwise is irrelevant. It may be noted that section 52 of the 2013 Act calls for transfer of premium collected on shares to ‘securities’ premium account. While both equity and preference shares may be issued at premium, generally only convertible debentures are issued at a premium. Section 52 of the 2013 Act is not attracted where the convertible debentures are issued at premium and are convertible at par. In such cases, the premium collected is either transferred to profit and loss account or amortized over the term of debentures. However, in cases where the debentures are issued at par, but are convertible at a premium, such premium is transferred to securities premium account, and the section id attracted.
Application of the Securities Premium Account
The securities premium account may be applied for the following purposes:-
- The paying up of fully paid bonus shares to be issued by the company to its members;
- The writing-off of preliminary expenses of the business registration;
- The writing-off of the expenses of, or commission paid or discount allowed on, any issue of shares or debentures of the company;
- The providing of a premium payable by the company on redemption of redeemable shares or redemption of shares or debentures of the company. However, under the 2013 Act this is subject to the provisions of Section 55(2) of the 2013 Act, which allows use of securities premium account to provide for premium on redemption of preference shares in certain cases only – for redemption of preference shares issued prior to commencement of the 2013 Act; and in case of companies falling under clause (d)(1) of the second provision to section 55(2).
- Purchase of its own Securities or other required securities in terms of section 77A of the 1956 Act;(now, this corresponds to section 68 under the 2013 Act).
Nature of Securities Premium Account
Share premium is a new class of capital of a company which is quasi-share capital but not distributable as income any more than any other capital asset. On a winding up the surplus monies in the share premium account will be returned to the shareholders as capital and so as long as the company is going concern. The same monies can never be returned to the shareholders except through the median of a reduction notice or, in other words, except under exactly the same requirements as those under which any other capital asset can reach the shareholder’s hands. Another effect of the section is that distribution of share ( now Securities) premium amount as dividend is not permitted. But premium received on the issue of shares, under the 1913 Act, were profits and so distributed as dividends.
Reduction of securities premium account
The court has a discretion whether or not to conform a reduction of a share (now securities) account and would normally to do so where;
- The shareholders are treated equally;
- The reduction proposals are properly explained;
- The creditors are safeguarded;
- The reduction is for a discernible purpose.
On the facts , the first two tests were satisfied. There were no danger to creditors since the use of the reserve created in the consolidated account by the reduction in the share(Securities) premium account to ‘write-off’ the goodwill in the consolidated accounts would not affect the creditors of the underlying companies since they were the creditors of a particular company and not of the group. The undertakings given to the court protected the creditors in the parent company whose securities premium account was being reduced. The fourth test was also satisfied since the purpose of the reduction was to create a reserve against which the goodwill arising in the future on the consolidation of the accounts could properly be set-off
Writing off Accumulated losses by utilizing share(Securities) premium account
The company proposed to write-off accumulated losses by utilizing the share premium account and by reducing the face value of the shares. The need and purpose of reduction was duly explained and discussed at an extraordinary general meeting of the company at which a special resolution was unanimously passed. The company had no creditors. The unsecured creditors had given their written consent. Nothing was shown to be there either against public interest or against law. The court allowed the proposed reduction. The share premium account is treated as paid up share capital for a limited purpose. But, it cannot be treated as a ordered fund. A company cannot write-off its losses against share (Securities) premium account unless there is a legal permission to that effect. A company can be allowed to write-off, or adjust a loss against share(now securities) premium account if there is no diminution of the share capital account.
Appropriation of Securities Premium Amount
Application of the amount in the premium account for any purpose other than those indicated in the section has been held to be not allowable. The company was attempting to wipe out losses incurred in investment in securities of other companies by taking-off the money from the premium account and reducing it accordingly. The Court did not permit it.
Reduction of Securities Premium Account for issuing bonus shares
The articles of the business registration permitted the securities premium account and Capital Redemption Reserve fund to be applied for paying up the unissued shares to members as fully paid bonus shares. The proposed reduction of capital neither involved diminution of liability in respect of unpaid capital, or payment to any shareholder of paid up capital. The court permitted the company to dispense with the procedural requirements of section 101(2) and approved the reduction.
Bonus issue by capitalization of share premium account
Bonus shares were issued by capitalization of the share (Securities) premium account. The issue was made without the authority of an ordinary resolution of the company. Further, the shares in respect of which bonus shares were not fully paid-up. This was held to be a mistake. The issue was void. It could not be regularized by the fact of informal agreement between the shareholders. Nor it could be said that the allottees of such shares were dealing with the company in good faith from outside so as to come within the protective scope of section 35A of the English Companies Act,1985.Talking to the essential nature of the bonus issue , the Court of Appeal said that profits and other available reserves are capitalized and applied to paying up unissued shares or debentures which were then issued to the existing shareholders in proportion to their entitlement to dividends. The defendants in this case, in failing to act with the authority of an ordinary resolution and issuing bonus to shareholders whose shares (Securities) were not paid up, had the effect that the directors had no power to capitalize any sum standing to the credit of the share( Securities) premium account or to appreciate it to members.
Reduction of securities premium account for tax payment
The business registration is carried out under section 78 of the 1956 Act for reduction of share (Securities) premium account for the purpose of meeting deferred tax liability. Shareholders had approved the reduction by a resolution. In keeping the order of the High Court a public notice was published for inviting objection was received. Reduction of the account was accordingly confirmed.
Cancellation of Securities Premium Account
In a New Zealand case the company sought conformation by the information of the special resolution to issue from time to time its securities premium account to its ordinary shareholders. The directors were to transfer from the revenue reserves to a special capital replacement fund an amount equal to the amount to be distributed. That fund was not to be available for payment of dividend nor to be distributed to shareholders, but could be applied in paying up unissued shares as fully paid bonus. No objections had been obtained from the creditors. The sundry trade creditors had been regularly paid. The Court said that the issued and distribution of the securities premium account is equal to an actual return of the paid-up capital and can only be made in precisely same way as a reduction of capital. The motives of the business registration enabling it to distribute dividends in part tax free in the hands of shareholders did not affect confirmation by the Court. Where there is a evidence of the company’s intention to pay its tax and its creditors, other than the monthly trade creditors, Consent to the reduction and the company is solvent, these are called “Special circumstances” in which the court may dispense with the provisions of the Act. The Court may dispense with an inquiry as to creditors on condition that a fund is held for their payment.
Reduction of premium per securities
A Company issued and distributed the convertible debentures. The conversion was to be at a stated rate of premiums. The market value of the shares was below the premium amount. The company passed a resolution for cancellation of the premium amount which was to be collected with the third and the final call. The objecting creditors interest was secured and safe by making deposit in the court. The resolution for reduction of securities was confirmed to be carried on.
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