NCLT Kolkata rejects reclassification of Securities Premium into Retained Earnings

Background

In a recent ruling, a petition was filed by Modern Hi-Rise Private Limited¹ (“the Company”) before the National Company Law Tribunal (“NCLT” or “The Tribunal”), Kolkata Bench, seeking approval for Reduction of Share Capital under Section 66 of the Companies Act, 2013 and Variation of Terms of Redeemable Preference Shares under Sections 48, 52, and 55 of the Act.

The Company intended to reclassify and transfer amounts from its Securities Premium Account to Retained Earnings for meeting redemption premium obligations of preference shares, as well as revise the redemption value of such shares.

Facts of the case

• The Company was incorporated in 2010 under the Companies Act, 1956.
• Pursuant to an NCLT-approved Scheme of Arrangement (2019), the Company had issued 1,41,34,192 Redeemable Preference Shares (RPS) of INR 10 each.
• The shares were originally redeemable at par anytime within 20 years from the allotment date. In 2024, the management, in consultation with preference shareholders, revised the redemption value to INR 120 per share, reflecting the fair value at issuance.
• This variation of terms was approved by passing a Board Resolution dated 01.08.2024 and obtaining the consent of the preference shareholders.
• Under Sections 55 and 52 of the Act, redemption premium is payable out of profits (retained earnings) or proceeds of a fresh issue. The Company, however, had insufficient retained earnings, though there was a substantial securities premium balance.
• The Company sought to reclassify Securities Premium into Retained Earnings to fund the redemption premium for preference shares.
• The Regional Director, MCA and the Registrar of Companies (RoC), West Bengal objected, stating:
  • Section 52 permits only specific uses of Securities Premium which does not include reclassification into Retained Earnings.
  • The proposal was inconsistent with Section 66 and Accounting Standards under Section 133.
  • Auditor’s certification failed to highlight this non-compliance, warranting ICAI scrutiny.

Key Issues

1. Whether Securities Premium can be reclassified and transferred to Retained Earnings for redemption purposes.
2. Whether the proposed capital reduction and variation of preference share terms are in conformity with Sections 48, 52, 55, and 66 of the Companies Act, 2013.

Key Takeaways

1. Reclassification of Securities Premium into Retained Earnings

• The NCLT held that Section 52 of the Companies Act, 2013 provides a closed and specific list of purposes for which the securities premium account may be used. Applying the doctrine of ejusdem generis (Latin for “of the same kind”), the NCLT emphasized that the securities premium account can only be used for the enumerated capital-related purposes under Section 52, and reclassification into Retained Earnings is not permitted.
• The Tribunal observed that Securities Premium and Retained Earnings are fundamentally different. A securities premium is a capital receipt arising from shareholders paying more than the par value for share whereas Retained earnings are earned profits, representing accumulated operational profits not yet distributed as dividends and are revenue in nature.
• Further, even for taxation purposes, Retained Earnings and Securities Premium are treated differently. Retained Earnings represent post-tax profits available for reinvestment, while Securities Premium is a capital receipt arising from the issue of shares above their nominal value, not subject to corporate income tax and restricted for specific uses by law.
• The Tribunal also held that deviating from standard accounting principles by using non-GAAP (Generally Accepted Accounting Principles) financial measures risks misrepresenting an entity’s financial health. The Companies Act, 2013 requires companies to prepare financial statements that provide a true and fair view of their financial position. Therefore, the Tribunal concluded that reclassification of securities premium into retained earnings is impermissible as it would violate both the Act and GAAP.

2. Validity of Capital Reduction and Variation of Preference Share Terms

• The NCLT held that redemption of preference shares under Section 55 must be funded only from profits (retained earnings) or the proceeds of a fresh issue, and not from reclassified capital reserves.
• The Tribunal noted that even though shareholders had consented and the Articles permitted capital reduction, the scheme contravened Sections 48, 52, 55, and 66, making it legally untenable.
• The Tribunal further observed that the Articles of Association must be consistent with the Companies Act; therefore, even if the AOA contains a specific clause, its legality is subject to the higher laws and cannot contradict them.
• Hence, the NCLT ruled that the proposed variation and capital reduction could not be sanctioned since they were inconsistent with statutory provisions and accounting standards.

Conclusion

The Tribunal dismissed the petition, holding that the proposed scheme sought to extend the statutory framework beyond its intended scope. By invoking the Doctrine of Ejusdem Generis, it emphasized that the permissible uses of Securities Premium are confined strictly to those enumerated in the Act, and no analogy can be drawn to treat it as equivalent to Retained Earnings. Consequently, the capital reduction and variation of preference share terms, being inconsistent with both statutory provisions and accounting principles, were declared unsustainable.

Kretha Comments

This case underscores the strict statutory framework governing utilization of Securities Premium under Section 52 of the Companies Act, 2013. The decision reiterates:

• Securities Premium is a capital reserve, not available for distribution as free reserves or reclassification into Retained Earnings.
• Any deviation risks misrepresentation of financial statements and violates GAAP.
• Even if shareholders consent and Articles of Association authorize, the transaction must withstand the overarching provisions of the Act and Accounting Standards.
• The ruling strengthens regulatory oversight by emphasizing that accounting treatments impacting shareholder equity must adhere strictly to the Companies Act and prescribed standards.

1. C.P. No. 238/KB/2024 ↩︎