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Conversion of loan to equity

Pooja (CS) (35 Points)

21 December 2014

A Private Company had taken unsecured loan from a Director in the month of July (It had not entered into any agreement with the Director). Now, the Company wants to convert the unsecured loan to equity. So, in what way the Company can convert the unsecured loan to equity and allot the shares to the Director? Do they have to follow private placement for conversion??

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3 Replies

P C Agrawal (Registered independent director Past Chairman of Aurangabad Chapter of ICSI Practicing Company Secretary at Aurangabad) (8229 Points)
Replied 23 December 2014

There are two options for further issue of shares:

1. Rights issue u/s 62(1)(a)

2. Private placement/preferential allotment u/s 62(1)(c) read with Sec.42

Rights issue is a simpler mode and requires only 2 returns to be filed with ROC as against 4 returns in private placement. Hence it is advisable.

There is a general misunderstanding in case of rights issue. Many of us think that we have to allot shares to all existing shareholders in case of rights issue. It is not correct. The Act only requires that new shares must be 'offered' (and not 'allotted') to all shareholders. It is not necessary that all shareholders have to apply for the shares as per the letter of offer. Even one shareholder can accept (either fullly or partly) the offer and others may decline or even renounce in favour of someone else.

It will be advisable to refund the loan by cheque and complete formalities for rights issue. In case the company does not have funds to repay, it can be planned in such a manner that cheque for share application money is given against the cheque for refund of loan on the same day. It can be possible if both the director and company have bank account in the same branch of the Bank.

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CS Ankur Srivastava (Company Secretary & Compliance Officer) (17848 Points)
Replied 26 December 2014

I fully agree with the views of Agarwal sir. But in such allotment please keep in mind that the allotment should be done at the fair market value of the shares and not on the face value in view of section 56 of the Income Tax Act which provides that if the shares have been allotted below the fair market value and exceeds Rs. 50000 in value the difference will be added in the income of the allottee.

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VISHWANATH (Company Secretary) (22 Points)
Replied 06 March 2015

Originally posted by : CS Ankur Srivastava
	I fully agree with the views of Agarwal sir. But in such allotment please keep in mind that the allotment should be done at the fair market value of the shares and not on the face value in view of section 56 of the Income Tax Act which provides that if the shares have been allotted below the fair market value and exceeds Rs. 50000 in value the difference will be added in the income of the allottee.

yes, agreed but how to know fair market value in private limited comapny, as per section 56 of Income tax; company have to justify the valuation. as per my concern it is done through valuation certificate on the base of NPV,