Converting dues into equity

Converting dues (creditors or loans) into equity is called 'Debt-to-Equity Conversion' or 'Issue of shares against consideration other than cash.' Here is the complete guide:

1. Legal Process (Companies Act):
- Pass Board Resolution and Shareholder Resolution (Special Resolution if private placement rules apply) authorising the conversion
- File Form PAS-3 (Return of allotment) with ROC within 30 days of allotment
- If the creditor/lender is a foreign entity: FEMA/RBI approval may be needed (ECB-to-equity conversion has specific RBI guidelines)
- Ensure the conversion is at a fair value determined by a registered valuer (Rule 8 of Companies (Share Capital and Debentures) Rules)

2. Accounting Treatment:
Entry in Company's Books:
Dr. Creditor / Loan Payable A/c         Rs. XXXX
Cr. Share Capital A/c (face value)       Rs. YYYY
Cr. Securities Premium A/c              Rs. ZZZZ
(where YYYY = face value of shares issued, ZZZZ = premium over face value)

3. Valuation: Shares must be issued at a price not less than the fair market value (FMV). For private companies, FMV is determined by a SEBI-registered merchant banker or CA using DCF or NAV method. Shares cannot be issued below face value.

4. Tax Implications:
- For the Company: No income tax on such conversion — it is a financing transaction
- For the Creditor: The conversion is a 'transfer' of the debt for capital gains purposes. The cost of acquisition of shares = amount of debt converted. Any premium on eventual sale of shares will be capital gains
- Section 56(2)(x): If shares are issued to creditor at a value significantly different from FMV, tax implications may arise for the recipient

5. Stamp Duty: Applicable on issue of share certificates as per state-specific rates

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Aashok Kumar Sharma

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