Redemption of Preference Shares: Meaning, Process, Conditions & Accounting

Preference shares are a special class of shares that usually give investors a fixed dividend and priority over equity shareholders when it comes to dividend payout and repayment of capital. Redemption of preference shares means the company repays that share capital to the preference shareholders according to the terms on which the shares were issued. Under Indian company law, this is not just an accounting step. It is also a legal process governed mainly by Section 55 of the Companies Act, 2013, which lays down when redeemable preference shares can be issued and how they can be redeemed. This makes the topic important for companies, finance teams, students, and business owners alike.

For businesses, redemption of preference shares often comes up during capital restructuring, investor exits, or long-term funding decisions. For students and professionals, it is an important concept because it combines company law, accounting treatment, capital redemption reserve, and premium adjustment. At MKDA, we help companies understand the legal and financial impact of capital transactions, including preference share issue, redemption compliance, and related accounting treatment.

What Are Preference Shares?

Preference shares are shares that carry certain preferential rights compared to equity shares. These rights usually include priority in receiving dividends and priority in repayment of capital at the time of winding up. In most cases, preference shareholders do not enjoy the same level of voting rights as equity shareholders, which is why they are often seen as a hybrid between equity and debt-like funding.

Key Features of Preference Shares

Preference shares generally come with a fixed dividend rate, though payment still depends on the company’s ability to declare dividend where required by law and terms. They rank ahead of equity shareholders for dividend and repayment of capital. Their voting rights are usually limited. They may also be issued with features such as redemption or conversion depending on what the company’s articles and issue terms allow.

Types of Preference Shares

Preference shares can be classified in different ways, including:

• cumulative preference shares
• non-cumulative preference shares
• participating preference shares
• non-participating preference shares
• redeemable preference shares
• convertible preference shares

Out of these, redeemable preference shares are especially important because they are issued with the understanding that the company will repay them after a specified time or on specified terms. Under the Companies Act, 2013, companies limited by shares generally cannot issue irredeemable preference shares, except in limited infrastructure-related cases allowed by law.

What Is Redemption of Preference Shares?

Redemption of preference shares means repayment by the company of the preference share capital to the holders of those shares. In simple terms, the company returns the money originally raised through those shares, subject to the terms of issue and the law. This is why the phrase what is redeemable preference shares is often linked to the idea of shares that are repayable after a fixed period or event.

A company may choose redemption for several reasons. It may want to reduce the burden of fixed dividend commitments, simplify its capital structure, replace old funding with fresh capital, or comply with the original issue terms. In business practice, redemption is often part of a broader financing or restructuring plan rather than just a standalone transaction.

For clients looking at capital planning, MKDA helps review whether redemption is legally possible, whether reserves are sufficient, whether a fresh issue is needed, and what accounting treatment should follow. That makes the process more structured and less error-prone.

Legal Provisions for Redemption of Preference Shares Under Section 55 of the Companies Act, 2013

The legal framework for redemption of preference shares in India is mainly found in Section 55 of the Companies Act, 2013. The section makes it clear that a company limited by shares cannot issue irredeemable preference shares after the commencement of the Act. It also states that redeemable preference shares can be issued only if the company is authorised by its articles, and generally they must be redeemable within a period not exceeding 20 years from the date of issue, subject to specific conditions. A special exception exists for certain infrastructure projects, where the period may exceed 20 years subject to prescribed conditions and phased redemption.

Main Conditions for Redemption

The law sets out some clear conditions for redemption:

• only fully paid-up preference shares can be redeemed
• redemption must be made either out of profits available for dividend or out of the proceeds of a fresh issue of shares
• if redemption is made out of profits, the company must transfer an amount equal to the nominal value of the shares redeemed to the Capital Redemption Reserve
• where there is a premium payable on redemption, that premium must also be provided for as permitted by law before redemption takes place

This is one of the most important sections for companies because a redemption done without following these conditions can create both legal and accounting problems. At MKDA, we support businesses in reviewing share capital terms, Articles of Association, reserves position, and compliance requirements before redemption is undertaken.

Sources of Redemption

There are two main lawful sources for redemption of preference shares.

Redemption Out of Profits

When preference shares are redeemed out of profits, the company uses profits that would otherwise have been available for dividend. But because capital is being repaid, the company must preserve its capital base by transferring an amount equal to the nominal value of the shares redeemed to the Capital Redemption Reserve, commonly called CRR.

Redemption Out of Fresh Issue

A company may also redeem preference shares out of the proceeds of a fresh issue of shares made for that purpose. In such cases, CRR is not required to the extent the redemption is funded through the fresh issue. This is why the source of redemption matters so much in both legal analysis and journal entries.

In practice, companies often use a mix of fresh issue and accumulated profits. That is where mistakes tend to happen. MKDA helps clients structure the redemption properly so the funding source, board approvals, and reserve treatment all line up correctly.

Capital Redemption Reserve (CRR)

Capital Redemption Reserve is a reserve created when redeemable preference shares are redeemed out of profits. The idea is simple: if profits are being used to return share capital, the company should transfer an equivalent amount to a capital reserve so that its capital base is not weakened. This protects creditors and preserves capital discipline.

The CRR created under Section 55 is not a free reserve for general use. The Act states that it may be used for issuing fully paid bonus shares to members of the company. This is a classic exam point and also an important compliance point for companies.

Premium on Redemption

Sometimes preference shares are redeemed at a premium, meaning the company pays more than the face value of the shares at the time of redemption. This premium is separate from the nominal redemption amount and must be provided for properly before redemption is completed. Depending on the facts and applicable treatment, premium can generally be adjusted using permissible sources such as the securities premium account or profits.

This is an area where both students and businesses make errors. Many focus only on the nominal value and forget that premium on redemption needs its own treatment. At MKDA, we review these transactions from both the accounting and compliance angle so companies do not miss critical adjustments.

Accounting Treatment of Redemption of Preference Shares

The accounting treatment depends on whether redemption is out of profits, fresh issue, or both, and whether there is any premium on redemption. But the broad accounting flow usually looks like this:

1. Entry for Fresh Issue of Shares

If the company raises a fresh issue for redemption, the fresh issue is recorded first.

2. Entry for Transfer to Capital Redemption Reserve

If redemption is out of profits, the amount equal to the nominal value redeemed from profits is transferred to CRR.

3. Entry for Premium on Redemption

If the shares are redeemed at a premium, the premium payable is adjusted from the appropriate account.

4. Entry for Amount Due to Preference Shareholders

The redeemable preference share capital account is closed and the liability to preference shareholders is recognised.

5. Entry for Payment

Finally, the amount due is paid to the preference shareholders.

This sequence helps keep the transaction legally and financially clear.

Practical Example of Redemption of Preference Shares

Suppose a company has 1,00,000 redeemable preference shares of ?10 each, fully paid. The total nominal value is ?10,00,000. Assume these shares are redeemed at a 10% premium, so the total premium payable is ?1,00,000, and the total amount payable to shareholders becomes ?11,00,000.

Now assume the company issues 50,000 equity shares of ?10 each at par and raises ?5,00,000 through fresh issue. The remaining nominal value of redemption, that is ?5,00,000, is funded out of profits. In that case:

• fresh issue used for redemption = ?5,00,000
• nominal amount redeemed out of profits = ?5,00,000
• CRR required = ?5,00,000
• premium on redemption = ?1,00,000

Journal Entry Illustration

For fresh issue of equity shares
Bank A/c Dr. ?5,00,000
To Equity Share Capital A/c ?5,00,000

For transfer to CRR
Profit & Loss A/c / General Reserve A/c Dr. ?5,00,000
To Capital Redemption Reserve A/c ?5,00,000

For premium on redemption
Securities Premium A/c / Profit & Loss A/c Dr. ?1,00,000
To Premium on Redemption of Preference Shares A/c ?1,00,000

For amount due on redemption
Redeemable Preference Share Capital A/c Dr. ?10,00,000
Premium on Redemption of Preference Shares A/c Dr. ?1,00,000
To Preference Shareholders A/c ?11,00,000

For payment to shareholders
Preference Shareholders A/c Dr. ?11,00,000
To Bank A/c ?11,00,000

This kind of step-by-step treatment is where legal reading and accounting logic come together.

Advantages of Redemption of Preference Shares

Redemption of preference shares can improve the capital structure of a company by removing a class of capital that carries a fixed dividend expectation. It can reduce long-term financial burden, simplify investor structure, and sometimes strengthen the relative position of equity shareholders in the company’s funding mix. In some cases, it also allows the company to replace older capital with more efficient funding.

For businesses planning a capital clean-up or restructuring, MKDA can help evaluate whether redemption is the right step, whether fresh issue is needed, and how the accounting and company law side should be handled together.

Difference Between Buyback and Redemption

Although the two are often confused, redemption and buyback are not the same thing.

The confusion usually arises because both involve the return of capital, but the legal route, purpose, and accounting treatment differ.

Common Mistakes Students and Companies Make

A very common mistake is forgetting that only fully paid-up preference shares can be redeemed. Another is ignoring the need to create the Capital Redemption Reserve when redemption is made out of profits. Some also forget to separately account for the premium on redemption. Others confuse redemption with buyback, leading to incorrect legal references and journal entries.

Companies sometimes also overlook practical steps, such as checking whether the Articles authorise such shares, whether reserves are sufficient, and whether the source of funds is being classified correctly. That is why professional review matters. MKDA supports clients with legal review, accounting treatment, and transaction documentation so the redemption process is handled properly from start to finish.

Redemption of preference shares means the company's repayment of preference share capital according to the terms of issue. Under Section 55 of the Companies Act, 2013, redeemable preference shares can be redeemed only if they are fully paid up and only out of profits available for dividend or the proceeds of a fresh issue of shares. If redemption is out of profits, the company must create a Capital Redemption Reserve. If redemption is at a premium, that premium must also be adjusted properly.

For students, this topic is important because it combines law and accounting into a single chapter. For companies, it matters because a redemption transaction affects capital structure, reserves, and compliance. At MKDA, we help businesses handle such transactions with clarity by bringing together an understanding of company law, financial review, and practical accounting support.

FAQs

Can preference shares be redeemed at any time?

Only if the terms of issue and the conditions under Section 55 are satisfied. The shares must be redeemable under the company’s articles and meet legal requirements.

Is CRR always required?

CRR is required when redemption is made out of profits, but not to the extent that the redemption is funded through a fresh issue of shares.

Can irredeemable preference shares be issued?

Generally, no. Companies limited by shares cannot issue irredeemable preference shares after the commencement of the Companies Act, 2013, except in limited cases allowed for certain infrastructure projects under prescribed conditions.

What happens if the premium is payable on redemption?

The premium must be provided for separately before redemption, using permissible sources such as securities premium or profits, depending on the facts and treatment.

What do you mean by redeemable preference shares?

Redeemable preference shares are preference shares issued on terms that the company will repay them after a fixed period or on specified conditions.

What is the maximum period for redemption?

Section 55 generally provides that redeemable preference shares should be redeemed within a period not exceeding 20 years from the date of issue, subject to the special exception for certain infrastructure projects.