Debentures are a type of debt instrument. As a result, when their term finishes, debenture holders get their principal amount returned. The process of repaying the company’s debt is known as debenture redemption.
When debentures are redeemed, the debenture obligation is discharged. To put it another way, the quantity of investment required for debenture redemption is high. Thus, economic businesses make enough provision from profits and accumulate money to reclaim debentures.
Once the redemption of debentures gets completed, the company will remove or reduce the value of debentures from its liability.
Normally, a debenture certificate will have all the terms of redemption. The redemption approach can be as follows:
The term “debenture” is derived from the Latin word “debere,” which means “to borrow.”
A debenture is a written document that acknowledges a debt and bears the company’s common seal. It includes a deal for repayment of principal after a certain term, at intervals, or the company’s discretion, as well as interest payment at a fixed rate due typically half-annually or yearly on fixed dates.
Types of debentures summarized in the table below:
ViewPoint | Type 1 | Type 2 |
Security | Secured Debentures | Unsecured Debentures |
Tenure | Redeemable Debentures | Non-Redeemable Debentures |
Mode of Redemption | Convertible Debentures | Non-Convertible Debentures |
Coupon Rate | Zero-Coupon Debentures | Specific Rate debentures |
Registration | Registered Debentures | Unregistered Debentures |
Features | Shares | Debentures |
Ownership in Company | Yes, Gives Ownership | Acknowledgment of Debt by Company |
Returns on Investment | Dividends and capital appreciation | Payment of Interest |
Repayment by Company | Not redeemed or returned | Redemption available |
Voting Rights | Yes, voting rights are available | Not available |
Risk of investment | High Risk | Low Risk |
Convertibility | Cannot be converted to other instruments | Can be converted to shares if the debenture is convertible debentures |
A company may issue a variety of debentures, which are classified as follows:
The business redeems the debentures by making a lump sum payment to the debenture holders at the maturity/expiry date specified in the terms specified during issuance.
If the debentures are not redeemed at a discount or premium, a lump sum payment equal to the total of the principal values of all debentures is paid out on the predetermined or maturity date specified in the debenture agreement. The issuing business may choose to repay the debenture value before it matures. Companies are better placed to simplify debenture payments since they know when they must pay them.
In the case of a lump sum or one-time payment, debenture holders need to be careful about the liquidity and solvency conditions of the company since redeeming an entire debenture amount can be done only if the company is well-capitalized and has comfortable liquidity positions.
Hence, the investors need to invest in such debentures only if the company has a good track record on such redemptions.
Under this procedure, debentures are often redeemed in installments on specific dates throughout the period the debentures are in place. Divide the whole amount of debenture debt by the whole number of years. It should be mentioned that the legitimate reclaimable debentures are verified by the source of drawing the necessary number of lots from the debentures due for payment.
It’s like repaying a loan in installments where we pay the principal amount along with interest. By the end of the debenture period, the entire debenture would be paid off along with interest. Similarly, the interest amount would also get reduced as the principal amount is paid off.
When a company acquires its debentures for the intention of canceling them, the act of acquiring and canceling the debentures constitutes debenture redemption by purchase in an open market.
If a company’s units are listed on a controlled exchange, it may also buy debentures on the open market. It will spare them the trouble of having to deal with administrative paperwork.
This type of redemption helps the company to maintain its liquidity since the company can go for redemption when the liquidity is high and cut its final redemption value and vice versa. Also, if the debentures are available at a discounted price, the company gains from such purchases.
Example:
Company XYZ issues debentures of Rs. 20 crore for 5 years and gets listed in the market. The company purchases Rs. 10 cr value of debenture after 2 years from the market when they have sufficient liquidity and thereby reduce their redemption liability.
In case of convertible debentures a company may redeem its debentures by exchanging them into shares or new debentures. If debenture holders believe the offer is advantageous, they may exercise their entitlement to convert their debentures into equity or a new category of debentures. These additional shares or debentures may be issued at face value, a discount, or a premium.
The businesses should bear in mind that the DRR account must be created in any financial institution in India that is approved by the Reserve Bank of India.
Some companies issue debentures with the option of call and put during redemption. The call option gives companies the right to purchase their debenture before or on the due date at a specific price. The put option provides the debenture holders the right to sell the debenture back to the company at an agreed price on or before the maturity period.
According to the requirements of the Companies Act of 1956, the firm is required to put aside a percentage of its income each year and transfer it to the Debenture Redemption Reserve for the redemption of debentures until the debentures are redeemed.
According to Section 117C of the Companies Act of 1956 (as amended in 2000):
(a) Where a firm issued debentures after the commencement of this Act, it must establish a Debenture Redemption Reserve for the repayment of such debentures, to which a sufficient sum shall be credited each year until such debentures are redeemed.
(b) The sum allocated to the Debenture Redemption Reserve must not be used by the corporation for any purpose other than debenture redemption.
The Securities and Exchange Board of India (SEBI) has established rules for debenture redemption:
1) Every firm must establish a Debenture Redemption Reserve if it issues a debenture that is redeemable after more than 18 months from the date of issuance.
2) Only non-convertible debentures and non-convertible portions of partially convertible debentures are required to establish a Debenture Redemption Reserve.
3) Before beginning the redemption of debentures, a firm must establish a Debenture Redemption Reserve equal to at least 50% of the debenture issuance amount.
4) Withdrawal from the Debenture Redemption Reserve is permitted only once the corporation has decreased 10% of the debenture debt.
The Debenture Redemption Reserve account is shown under “Reserves and Surpluses” on the liability side of the Balance sheet. When debentures are redeemed, the appropriate amount of Debenture Redemption Reserve is moved to General Reserve.
Understand with an example:
Assume a business issued 10 Crores in debentures on January 10, 2021, with a maturity date of December 31, 2025. In this situation, a 1 Crore (10% x 10 Crore) debenture redemption reserve must be established before the debenture’s maturity date.
Companies who fail to establish such reserves within 12 months of an issue of the debentures will be obliged to pay debenture holders 2 percent interest in penalties. Companies, however, are not required to immediately fill the reserve account with a hefty deposit. Instead, they do have the option of replenishing the account by a sufficient amount each year to meet the 10% threshold.
Companies must also reserve or deposit at a minimum of 15% of the number of their debentures set to maturity on March 31 of the following year by April 30 of each year. These monies, which may be placed in a scheduled bank or deposited in corporate or government bonds, must be used to repay interest or principal payments on debentures expiring during the fiscal year that can be used for any other purpose.
When the firm agrees to create the Debenture Redemption Reserve Account, the value specified by the Debenture Redemption Reserve tables is deposited into the account and deducted from the profit and loss account. This demonstrates the company’s desire to put aside an amount of cash to develop a fund for repaying debentures. The business should immediately buy outside capital.
If the debentures are acquired during the interest period, the price includes interest if they are purchased “cum-interest,” but if they are purchased “ex-interest,” the interest until the date of purchase is due to the seller in addition. To offset the impact, the amount of interest accumulated up to the date of purchase, if paid, is charged to the Interest Account, whereby the interest for the whole term will be credited. As a consequence, the account balance would be equal to the interest earned throughout the time wherein the debentures were kept by the company.
Sr No | Debentures issued company | DRR Requirement |
1 | For both public and privately issued debentures, the Reserve Bank of India regulates All India Financial Institutions (AIFIs) and Banking Companies. | Not Applicable |
2 | Other Financial Institutions (FIs) within the meaning of clause (72) of section 2 of the Companies Act, 2013 | DRR needs to be created |
3 |
For listed companies
A) All listed NBFCs (registered with RBI under section 45-IA of the RBI Act, 1934) and listed HFCs (Housing Finance Companies registered with National Housing Bank) for both public as well as privately placed debentures
B) Other listed companies for both public as well as privately placed debentures |
No DRR Required
No DRR Required |
4 |
For Unlisted Company A) All unlisted NBFCs (registered with RBI under section 45-IA of the RBI (Amendment) Act, 1997) and unlisted HFCs (Housing Finance Companies registered with National Housing Bank) for privately placed debentures
B) Other unlisted companies
|
No DRR Required
DRR Shall be 10% of the value of outstanding debentures issued |
A debenture trustee works to safeguard the debenture investors and enforces the debenture trust deed. A debenture trustee ensures that the debentures were turned or redeemed in line with the requirements and circumstances under which they were issued to debenture holders.
A debenture trustee is a trustee of a deed of trust to ensure a body corporate’s issuance of debentures. The entity acting as debenture trustee must be either a scheduled bank engaged in commercial business, a major public bank, an insurance company, or a corporate body. To function as a debenture trustee, the firm must be registered with SEBI.
It depends. If you are holding convertible debentures, then they will be converted to equity shares of the company, but if you are holding non-convertible debentures, then they cannot be converted. If the company becomes insolvent to pay back the debenture amount, you have to wait for the insolvency process to complete.
The Interest payment will be decided during the issue of debentures. If it’s a fixed interest debenture, the interest will be paid at a specific period, as mentioned in the issue document. In the case of zero-coupon debentures, there will be no fixed interest payments.
Yes, Debentures come under the category of asset, and hence any capital gain during sale or redemption will be subject to capital gain tax. Kindly refer to the capital gain tax provision to understand more about the tax rates and applicability.
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