Question

Question 2 (Note this question is from the Week 4 Tutorial) (a) What are the most common reasons for a corporation to reduce its share capital? (b) What are the allowable methods of reducing share capital? (c) Discuss the differences between a share buyback and a capital reduction. (d) What are the different types of debt instruments discussed in this unit? (1 mark)

Answer 1

a. ) There are various reasons for a corporation to reduce its share capital. Some of them are as follows:-

1. To return the Surplus capital to its existing Shareholders.

2. To facilitate Redemption of Shares or Share Buyback.

3. It may be sometime consider as a part of arrangement in corporation

4. To increase or make distributable reserve for future dividends to be paid to its existing shareholders.

b.) Allowable method of reducing Share Capital for a Corporation are as follows:-

1. Corporation can reduce the liability of shares in respect of existing share capital not paid.

2. Paid off any paid up share capital which is in excess.

3. Corporation can cancel any paid up share capital which is lost or is unrepresented by available assets.

c.) Difference between Share buyback and Capital Reduction:-

Reduction in capital- It means when a corporation reduces its share capital or any money paid to the corporation in respect of member's share is returned to the member. For eg. At present, face value of a share is Rs.100, Corporation reduces face value of share to Rs.80 and refunds Rs.20 to the member/shareholder. It generally happens when Corporation is undergoing internal reconstruction.

Buyback of shares- When a corporation has surplus distributable funds it either declares dividend or buys back its own shares. So buyback of shares means when corporation acquires shares from existing shareholders and cancels these shares from the market. Section 115QA of Income Tax Act,1961 applies in case of buyback of shares.

d.) A Debt instrument is a fixed income asset in the market that allows the lender (or giver) to earn a fixed interest on it and after that getting the principal amount back while the issuer (or taker) can use it to raise funds at a cost.

Different type of Debt Intrument:-

1. Debentures- They are issued by the corporation to raise medium and long term funds. They form a part of capital structure in the corporation and reflected in balance sheet but not clubbed with Share Capital.

2. Bonds- Bonds are issued generally by the government, central bank or large corporations are backed by a security. Bonds also ensure payment of fixed interest rates to the lenders of the money. On maturity of the bond, the principal amount is paid back.

3. Mortgage- A mortgage is a loan against a residential property. It is secured by an associated property. In a case of failure of payment, the property can be seized and sold to recover the loaned amount. This is very easy way in case of debt Instrument.

4.Treasury Bills- Treasury bills are short-term debt instruments that mature within a year. They can be redeemed only at maturity. They are sold at a discount if sold before maturity.