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Explained: How To Convert Equity Shares To Preference Shares

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Equity shares are ordinary stocks or shares that are categorized as an investable security conferred by the respective companies to the masses. To simplify the pathway for the companies and give their shareholders an orderly exit, the National Company Law Tribunal has proposed a scheme.

The Mumbai Bench of the Tribunal has passed on a scheme offering the effective conversion of equity shares to preference shares. As per the report published in The Hindu Business Line, the Tribunal believed that the conversion of equity shares into preference shares could not be critically forbidden as stated by the Registrar of Companies (ROC).

This piece discusses the method to convert equity shares into preference shares. Click here to know more.

Equity shares vs Preference shares

Before decoding the means to convert equity shares into preference shares, it is important to understand the difference between them. The primary difference is that preference shares are entitled to the preferential rights of the company while repayment of capital or payment of dividend; however, equity does not enjoy this privilege as they are the real owners of the company.

  1. The dividend rate of preference shares cannot be changed or converted, however the dividend rate keeps fluctuating in equity share capital.
  2. Preference shareholders do not enjoy any voting rights while equity shareholders, being the controllers, enjoy voting rights.
  3. Since preference shareholders do not hold any rights to vote, they do not participate in the management too. Therefore the shareholders upholding equity shares bear the maximum risk.

Assurance by the Tribunal

The Tribunal discussed the suggestions of the company and proposed a conclusion that whenever shares of the first party are converted to the other, the paid-up capital remains unaltered. So in order to convert the equity shares to preference shares, the change should not distort the paid-up capital and subscribed capital.

Since the law of the land does not endorse such conversion, the Tribunal said that any interested person that also includes a minority shareholder is eligible to appeal to the Tribunal related to this matter for any necessary directions.

The Conversion

The shareholders holding equity shares cannot directly convert into preference shares. Since this is a permanent capital, you will first have to reduce its value by reissuing it as a preference share and then own it. The equity cannot be converted entirely into a preference but can be issued through the buy-back.

Section 45 of the Indian Income Tax Act, 1961 is concerned with the taxable capital gains incurred from capital assets in the past financial year. To decipher this act in simpler terms, the income earned from the shift of capital assets is a capital gain and thereby subjected to tax.

Preference shares are ephemeral in nature. Due to which there might be a possible issue involved in conjunction to Section 45 of the IT Act. If you want to convert equity shares into preference shares and try to redeem the amount, you might face a loophole in the process. The gain will be subjected to the rule stated by Section 45 and there won’t be any capital left with the company.

According to Section 43 of CA 2013 observes equity and preference at the same pedestal in the company’s share capital. When the equity shares are converted into preference shares the subscription value and paid-up capital do not witness any further alteration. However, the nomenclature changes.

Conclusion

Equity shares and preference shares are the core elements in a business to generate funds. The conversion of equity shares into preference shares is not yet followed in complete force, however, with new provisions coming up, shareholders can seek the Tribunal for further assistance.

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