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Preference shares likely to get quasi-debt status

Thomas K Thomas

The government is considering a proposal that will lend flexibility to Indian companies by allowing them to attract foreign investment without breaching the foreign direct investment cap.

The move follows representations by several companies in the banking, media, insurance and telecom sectors.

The proposal, based on the recommendations of the committee of secretaries (CoS) on FDI, seeks to amend Section 208 of the Companies Act and allow companies across all sectors to issue preference shares and treat them as quasi-debt instruments.

Preference capital, which can carry an interest rate of not more than 12 per cent, can be issued without government sanction or even a special resolution. A board resolution was enough, the committee said.

The committee has also recommended an amendment to Section 78 of the Companies Act. The amendment provides for payment of dividend to preference shareholders from the securities premium account if the company is not in a position to pay dividend out of its profit.

To prevent preference shareholders from getting voting rights, the committee has also proposed an amendment to Section 87 of the Companies Act.

The amendment will provide for limiting the voting rights of foreign investors even if the dividend remains unpaid for three consecutive years.

According to the committee, the amendment to Section 78 will act as an incentive to foreign investors because they will be assured of a return on their investments.

Also, this will help Indian companies to retain management control by paying dividend from the share premium account. However, new companies will not be able to benefit from the amendment.

However, the amendment to Section 208 allows treatment of preference shares as quasi-debt instruments. The committee notes that payment to shareholders will be in the nature of "interest" and not "dividend".

The shareholder, in this case, can receive "interest" payment and still claim voting rights under Section 87 by treating it as "dividend". However, this can be prevented if all amendments are enforced.

The proposed amendments to Sections 78, 87 and 208 would give a fillip to companies like BPL Communication which defaulted on payment of dividend to its preference shareholder, CDC.

CDC, it might be recalled, had demanded voting rights in lieu of this default.

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