Introduction
Practically speaking, there are 3 ways for further issue of share capital by a Company, when it wants to increase its subscribed capital, such shares can be tendered by way of:
Rights Issue : (Section 62(1)(a)
Employee Stock Option Plan : (Section 62(1)(b)
Issue on preferential basis : (Section 62(1)(c)
In this article, we will discuss statutory provisions governing issuance of shares through rights issue basis and its procedure.
When a Company needs additional working capital and have to keep the voting rights of the existing members proportionately balanced, the Company issues shares on rights basis. The issue is called so, as it gives the existing members a pre-emptive right to buy new shares at a price that is lesser than market price. The Rights issue is an invitation to the existing equity members to buy new shares in proportion to their existing shareholding. Further, if the existing equity members don’t want to buy shares offered to them, they can also renounce shares in favor of any other person.
Definitions
Private Company: As per Section 2(68) of the Companies Act, 2013, Private Company means a company having a minimum paid-up share capital as may be prescribed, and which by its articles:
(i) restricts the right to transfer its shares;
(ii) except in case of One Person Company, limits the number of its members to two hundred:
Provided that where two or more persons hold one or more shares in a company jointly, they shall, for the purposes of this clause, be treated as a single member:
Provided further that:
(a) persons who are in the employment of the Company; and
(b) persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased,
shall not be included in the number of members; and
(iii) prohibits any invitation to the public to subscribe for any securities of the Company.
Public Company: As per Section 2(71) of the Companies Act, 2013, a Public Company means a Company which:
a. is not a private company;
b. has a minimum paid-up share capital, as may be prescribed;
c. subsidiary of a public company shall be deemed to be a public company.
Share: As per Section 2(84) of the Companies Act, 2013 share means a share in the share capital of the Company and includes stock.
Rights Issue: An offer letter issued to existing equity members of the Company in proportion to the paid-up share capital held by them at the time of issue of shares and such offer letter contains the right to renounce shares as well.
It is also called “Pre-Emptive Right”. Pre-Emptive Right means the existing members have preferential rights to avail the offer other than the outsiders.
Statutory Provisions Governing Rights Issue of Shares
(i) Section 62(1)(a) of the Companies Act, 2013; and
(ii) Rule 12A of Companies (Share Capital and Debentures) Rules, 2014
Understanding the concepts related to Rights Issue
Conditions Precedent to the Issue of Shares on Rights basis:
a) Check whether the rights issue results in increase in authorized share capital;
b) If so, call a board Meeting to approve the notice of General Meeting to pass Ordinary Resolutions at the General Meeting to amend Clause V of Memorandum of Association.
c) Convene the General Meeting and obtain members approval through Ordinary Resolution.
d) The offer shall be made by notice:
- Specifying the number of shares offered; and
- Limiting a time not being less than 15 days or such lesser number of days as may be prescribed and not more than 30 days from the date of offer within which the offer, if not accepted, shall be deemed to have been declined.
In the case of a Private Company, the time limit for acceptance could be even less than 15 days, if 90% of the total members of the Company have given their consent by passing a resolution to it either in writing or through electronic mode.
- The offer shall be deemed to include right of renunciation, unless the articles of association otherwise provide; and the notice referred above contain statement of this right;
- If the offer is rejected by the equity members after the expiry of the time specified in the notice aforesaid; or
- On receipt of earlier intimation from the person to whom such notice is given that he declines to accept the shares offered;
- The Board of Directors may dispose of them in such manner which is not dis-advantageous to the members and the Company.
The said notice shall be dispatched through registered post or speed post or through electronic mode or courier or any other mode having proof of delivery to all the existing equity members at least 3 days before the opening of the issue.
Unless the articles of the Company otherwise provide, the Directors must state in the notice of offer of rights shares the fact that the member has also the right to renounce the offer in whole or in part, in favor of some other persons.
Procedure for Issue of Shares on Rights Basis
| Step No. | Procedure | Timeline, if any |
| (1) | Calling of Board Meeting for approving issue of equity shares on rights issue basis to existing equity shareholders of the Company:
Ø Issue Notice for holding Board Meeting to all the Directors of Company at their addresses registered with the Company. [Section 173 of Companies Act, 2013 and SS-1 to be adhered] Provided that if Board Meeting is called at a shorter notice, then shorter notice consent letters shall be signed by all the Board of Directors of the Company. Ø Attach agenda, notes to agenda and draft resolution with the notice of Board Meeting. Ø Hold the meeting of Board of Directors of the Company on the day, date, time & venue stipulated in the notice and pass the necessary Board Resolution in respect of the following: a) To take approval for issue of equity shares on rights issue basis to the existing equity shareholders of the Company; Ø Draft minutes of the board meeting shall be circulated to all the directors within 15 days from the date of conclusion of the meeting by hand delivery or by registered post or by speed post or by courier or by email or by any other recognised electronic means. [Section 118(1) of the Companies Act, 2013 read with Clause 7.4 of Secretarial Standard on Board Meeting-1 promulgated by the Institute of Company Secretaries of India]. |
Notice needs to be given at least 7 clear days before the date of Board Meeting |
| (2) | Issuance of Offer Letters to all the existing equity shareholders of the Company:
After approval of offer letter, it shall be sent to all the existing shareholders of the Company. Shareholders can accept number of shares offered to them within a window period of 15-30 days. The offer is considered declined if it is not accepted within window period of 15-30 days. Note: Offer letter shall be opened after 3 days from the date of Board Meeting. |
Offer letter shall be opened for a period of 15-30 days as specified in Offer letter. |
| (3) | File Form MGT-14:
After the passing of board resolution, the company must file the MGT -14 within 30 days of passing of the Board Resolution. The form MGT 14 is mandatory for a public limited company. A true certified copy of the Board Resolution needs to be attached to MGT 14. However, in case of private company, there is as such no requirement of filing MGT-14, as the same has been exempted by MCA vide its Notification No. 464(E) dated 5th June, 2015 |
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| (4) | Renunciation of Shares offered to existing equity shareholders:
Existing equity shareholders to whom shares are offered in proportion to their share capital, can renounce shares in favor of any other person as well. |
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| (5) | Rejection of Offer:
If the shareholders decline the offer of shares offered to them, Company or Board of Directors have right to dispose them in such a manner, as they deem fit. Provided that same should not be detrimental to the members and the Company. |
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| (6) | Acceptance of Offer and Receipt of Application Money:
After the acceptance of offer by equity shareholders, amount shall be credited in the Company’s bank account by shareholders. |
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| (7) | Calling of Board Meeting for allotment of shares on rights basis:
After receipt of subscription amount from the existing equity shareholders or persons in whose favor shares are renounced by existing equity shareholders (Outsides or Third Party), Company shall convene another board meeting for allotment of shares: Ø Issue Notice for holding Board Meeting to all the Directors of Company at their addresses registered with the Company. [Section 173 of Companies Act, 2013 and SS-1 to be adhered] Provided that if Board Meeting is called at a shorter notice, then shorter notice consent letters shall be signed by all the Board of Directors of the Company. Ø Attach agenda, notes to agenda and draft resolution with the notice of Board Meeting. Ø Hold the meeting of Board of Directors of the Company on the day, date, time & venue stipulated in the notice and pass the necessary Board Resolution in respect of the following: a) To allot share on rights issue basis. Ø Draft minutes of the board meeting shall be circulated to all the directors within 15 days from the date of conclusion of the meeting by hand delivery or by registered post or by speed post or by courier or by email or by any other recognised electronic means. [Section 118(1) of the Companies Act, 2013 read with Clause 7.4 of Secretarial Standard on Board Meeting-1 promulgated by the Institute of Company Secretaries of India]. It is pertinent to note here that: a) Date of transfer will be date of board meeting in which transfer has been taken on record; and b) Once share transfer deed is received and board meeting is convened by Company, it is necessary to fill “For Office Use” given in Form SH-04. Many a times Company’s miss to fill “For Office Use’ and this finding comes when due diligence of Company is being done. |
Notice needs to be given at least 7 clear days before the date of Board Meeting |
| (8) | File Form PAS-03 with ROC:
File form return of allotment in Form PAS-3 within 30 days of passing Board Resolution for allotment of shares. Attachment: Ø Certified true copy of Board Resolution; Ø List of allottees in excel format; Ø Proof of payment received from the allottees viz. Bank statement of Company with credit transaction entries showing amount received and Bank statement of allottees with debit entries showing that they have paid money to the Company. |
Within 30 days from the date of allotment of shares |
| (9) | Updating Register of Members in Form MGT-01:
Company shall update its Register of Members in Form MGT-01 |
Within 7 days from the date of board meeting in which transfer is approved |
| (10) | Issuance of Share Certificates:
Company shall issue share certificate in Form SH-01. |
Within 60 days from the date of allotment |
Taxability on Rights Issue of Shares
Rights Shares issued to shareholders do not attract any incidence of taxation. However, at the time of sale by shareholders, such sale of shares attracts capital gain tax.
Capital Gain Tax
When the shareholder actually sells the shares. The incidence of sale will attract capital gains tax. The gains can be either long term or short term, depending on the period for which the employee has held the shares. In case of unlisted equity shares, period of holding is 24 months. Short term capital assets – when sold within 24 months of holding them and long term capital assets – when sold after 24 months of holding them.
Short term capital gains (STCG) are taxed at income tax slab rates applicable to individuals. Long-term capital gains (LTCG) are taxed after applying the indexation to the original cost of purchase. Indexed gains so calculated shall be taxed at a flat rate of 20% plus applicable surcharge and education cess.
Epilogue
Rights issue of shares can be done very easily and without calling upon shareholders meeting, as first offer of shares is given to existing shareholders. No valuation report is required, as there is no statutory requirement of taking any valuation report for arriving at fair market value of equity shares. However, as a general practice, it is advisable to take valuation report from Registered Valuer.
It is also a fast source of raising funds without any increase in debt. Further, Board of Directors cannot misuse their power of issuing shares at a lower price. As rights shares are offered proportionately to the existing shareholders only.
From taxation point of view, no income tax is attracted at the time of issuing shares to shareholders. At time of sale, capital gain tax is attracted.
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The author can also be reached out at harsh@sarvaankassociates.com or can be contacted at +91-8171445822.
Author Bio
As per Income Tax what will be the status of Rights Issue to Share Holders under Section 56(2)(x).