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Private companies: redemption or purchase of shares out of capital The Companies Act 1981 introduced a new power for

a private company to redeem /p urchase its own shares where either it has insufficient distributable profits fo r the purpose or it cannot raise the amount required by a new issue. Previously it would have had to apply to the court for capital reduction (which you will le arn about in Chapter 9). The 1981 legislation made it far easier to achieve the same objectives, in terms of both time and expense. The full details of the various matters which must be dealt with by private comp anies who pursue this option are beyond the scope of this textbook. If you wish to go into this topic in greater detail, you will need to consult a book on comp any law. For our purposes, a very brief outline is as follows: 1 The private company must be authorised to redeem or purchase its own shares o ut of capital by its Articles of Association. 2 Permissible capital payment is the amount by which the price of redemption or purchase exceeds the aggregate of (a) the company s distributable profits and (b) t he proceeds of any new issue. This means that a private company must use its available profits and any share proceeds before making a payment out of capital. (This is dealt with in greater d etail in the next section.) 3 Directors must certify that, after the permissible capital payment, the compa ny will be able to carry on as a going concern during the next twelve months, and be able t o pay its debts immediately after the payment and also during the next twelve months. 4 The company s auditors make a satisfactory report. Activity 5.3 Why do you think the rules are less restrictive for private companies? 5.8 Permissible capital payments 1 Where the permissible capital payment is less than the nominal value of share s redeemed / purchased, the amount of the difference shall be transferred to the capi tal redemption reserve from the profit and loss appropriation account (or from undistributed pr ofits). 2 Where the permissible capital payment is greater than the nominal value of sh ares redeemed / purchased, any non-distributable reserves (e.g. share premium account, c apital redemption reserve, revaluation reserve, etc.) or fully paid share capital can be r educed by the excess. 79

Part 2 l Companies This can best be illustrated by taking two companies, R and S, with similar acco unt balances before the purchase/redemption, but they are redeeming their shares on different terms: (Note: To ensure maximum clarity, the values used have been kept unrealistically low.) Exhibit 5.7

Before Dr Cr After Company R Net assets (except bank) 2,500 2,500 Bank 7,500 (B2) 4,000 3,500 10,000 6,000 Ordinary shares 1,000 1,000 Preference shares 4,000 (A1) 4,000 Non-distributable reserves 2,000 2,000 Capital redemption reserve (C2) 3,000 3,000 Preference share purchase (B1) 4,000 (A2) 4,000 7,000 Profit and loss 3,000 (C1) 3,000 10,000 6,000 The preference shares were redeemed at par, 4,000. No new issue was made. (A1) and (A2) represent transfer of shares redeemed/purchased. (B1) and (B2) represent payment to shareholders. Therefore pay 4,000 Less Profit and loss account (3,000) Permissible capital payment 1,000 Nominal amount of shares redeemed/purchased 4,000 Less Permissible capital payment (1,000) Deficiency to transfer to capital redemption reserve (C1 and C2) 3,000 The steps taken were: Dr (A1) Preference shares 4,000 (A2) Preference share purchase (B1) Preference share purchase (B2) Bank 4,000 (C1) Profit and loss 3,000 (C2) Capital redemption reserve Before Dr Cr After Company S Net assets (except bank) Bank 7,500 (D2) 7,200 10,000 2,800 Ordinary share capital 1,000 Preference shares 4,000 Non-distributable reserves Capital redemption reserve Preference share purchase (B2) 3,000 (C2) 200 7,000 2,800 Profit and loss 3,000 (B1) 10,000 2,800 80 Cr 4,000 4,000 3,000 2,500 300 1,000 (A1) 2,000 (D1) 2,500

4,000 (C1) 7,200

200 (A2)

1,800 4,000


Chapter 5 l Companies purchasing and redeeming their own shares and debentures The preference shares were redeemed/purchased at a premium of 80%. No new issue was made. (A1) and (A2) represent shares redeemed /purchased. (B1) and (B2) are transfers to redemption /purchase account of part of source of funds. (D1) and (D2) are payment to shareholders.

Therefore pay 7,200 Less Profit and loss account (3,000) Permissible capital payment 4,200 Permissible capital payment 4,200 Less Nominal amount redeemed/purchased (4,000) Excess from any of non-distributable reserves (or capital) (C1 and C2) 200 The steps taken were: Dr Cr (A1) Preference shares 4,000 (A2) Preference share purchase 4,000 (B1) Profit and loss 3,000 (B2) Preference share purchase 3,000 (C1) Non-distributable reserves 200 (C2) Preference share purchase 200 (D1) Preference share purchase 7,200 (D2) Bank 7,200