Debentures Redemption Reserve

The amount required for the redemption of debentures is usually very large. It creates a great difficulty for the company to arrange this large amount to pay off its debentures. In case this large amount is paid out of company’s working capital, it may affect the routine working of the company and that will affect the profitability of the company also. So in order to avoid this difficulty a company needs funds to repay its debentures. Debenture redemption reserve is a capital reserve into which amounts are transferred from the profit and loss account for debentures that are redeemable at a future date. The aim is to limit the profits available for distribution.

According to a notification of Government of India issued by Controller of Capital Issue as on 1-1-1987, it is compulsory for all companies to create a Debenture Redemption Reserve up to at least 50% of the amount of debentures issued before the commencement of redemption of debentures. The effect of such a notification is that a Company cannot redeem its debentures purely out of capital or purely out of current profits.

The new Section, introduced through the Companies (Amendment) Act 2000, requires all companies that have issued debentures and are making profits to create debenture redemption reserve (DRR). The DRR is to be created only out of the profits of the company and has to be “adequate.”

The purpose of introduction of Section 117C in the Act was to protect the debenture holders in case of any eventuality of the company going broke. The reserve is expected to be maintained by providing “adequate” funds from profits to cover any such eventuality.

Section 117C mandates that a debenture redemption reserve shall be created to which shall be transferred adequate amounts of the profits of each year and that the said reserve shall not be used by the company except for the purpose of redemption. It is further provided that if the company fails to redeem the debentures with interest, the company law board on an application being made shall direct by an order, the company to redeem the debentures forthwith by the payment of the principal amount and the interest. Failure to comply with the above conditions is visited by suitable penalty.