Capital Redemption Reserve (CRR) : Uses, Tax Benefits, Calculation & Journal Entries

What is Capital Redemption Reserve?

Capital redemption reserve is a reserve that is created by the company out of its profits, during the redemption of preference shares. When a company proposes redemption or buy-back of its share, the capital base is reduced. To compensate for the reduction, a portion of the profit needs to be allocated separately. The allocated portion should be transferred to the Capital Redemption Reserve. The capital redemption reserve shall not be treated as a revenue reserve.

Geeky Takeaways:

• It is a sum set aside from the profits equal to the face value of the shares which are to be redeemed.
• The amount of capital redemption reserve can not be distributed to the company’s shareholders.
• Capital redemption reserve acts as a source of funding during buy-back.
• The amount can be utilized by the company to issue fully paid bonus shares to its members.

Importance of Capital Redemption Reserve

1. Safeguard the Interest: The Capital Redemption Reserve(CRR) is created to safeguard the financial position of the company by setting aside an amount out of its profit for the redemption of its preference shares. It is also established to safeguard the interests of the creditors by maintaining a reasonable level of capital within the company.

2. Redemption of Preference Shares: Section 55 of the Companies Act, 2013 makes it mandatory for companies limited by shares proposing to redeem their preference shares out of profits, to transfer the sum equal to the nominal value of preference shares which are to be redeemed to a capital redemption reserve account.

3. Compliance: Section 55 of the Companies Act,2013 makes it mandatory for companies limited by shares proposing to redeem their preference shares out of profits, to transfer the sum equal to the nominal value of preference shares which are to be redeemed to the capital redemption reserve account. Establishing a capital redemption reserve account is important to ensure compliance with the act.

4. Buy-Back of Shares: When a company decides to purchase its shares, the capital redemption reserve acts as a source of funding. The company needs to transfer an amount equal to the face value of the shares so bought back to the capital redemption reserve account. Details of such transfers shall be disclosed in its balance sheet.

5. Stability of the Company: The capital redemption reserve account is created by setting aside some of the company’s profits. It ensures that the company has enough funds to meet any future losses and helps maintain the financial stability of the company and its integrity.

6. Dividend Policy: The creation of a capital redemption reserve affects the company’s dividend policy. The amount of CRR is not allowed to be distributed among the shareholders in the form of dividends which encourages the company to allocate the profits carefully between the dividends and reserve. This ensures a balance between rewarding shareholders and maintaining financial flexibility.

Companies Act and Capital Redemption Reserve

Companies Act, 2013 mandates transferring the amount to capital redemption reserve in the following two cases,

1. Redemption of Preference Shares: Section 55 of the Companies Act, 2013 makes it mandatory for companies limited by shares proposing to redeem their preference shares out of profits, to transfer the sum equal to the nominal value of preference shares which are to be redeemed to a capital redemption reserve account.

2. Buy-Back of Shares: According to section 69 of the Companies Act, 2013, where a company proposes to buy back the shares out of its free reserve or security premium account, it shall transfer an amount equal to the face value of shares so bought back to the capital redemption reserve account. The company must disclose the details of such transfers in its balance sheet.

The object behind mandating the creation of a capital redemption reserve account is,

• Protect the Interest of Creditors: The Capital Redemption Reserve is typically used to protect the interests of creditors and shareholders by maintaining a pool of funds that can be used to cover any capital reduction resulting from share buybacks.
• Stability of the Company: The capital redemption reserve account is created by setting aside some of the company’s profits. It ensures that the company has enough funds to meet any future losses and helps maintain the financial stability of the company and its integrity.
• Reduction of Share Capital: It is a financial mechanism to account for the reduction in share capital when a company repurchases its own shares.

When is Capital Redemption Reserve Used?

1. Bonus Issue: The capital redemption reserve account is used by the companies in issuing fully paid-up bonus shares to its existing members. Bonus shares are those shares, which a company issues to its existing members free of cost.

2. Redemption of Shares: The main purpose of the CRR is to provide funds for the company during the redemption of its shares. This reserve safeguards the reduction of the company’s share capital.

3. Capital Reconstruction: Capital reconstruction happens when there is a change in the share capital of the company. The CRR can be utilized to ease this process. It can be used for the conversion of shares from one class to another or to change the nominal value of shares.

4. Balancing of Capital Losses: If a company incurs capital losses, it can utilize the CRR to balance these losses. It helps in protecting the shareholders’ investments and ensures the financial stability of the company.

5. Source of Fund: It is an account that holds the amount equivalent to the reduction in share capital. If at any time the company decides to finance the share buyback through its profits or reserves, the capital redemption reserve serves as a source of funds.

Tax Benefit for Special Reserve

As per section 36(1)(viii) of the Income Tax Act, 1961, the eligible entities are allowed to get a deduction on Special Reserve created under this section which results in the reduction of tax liability.

In some cases, contributions to certain reserves may be tax-deductible. This means that when a company sets aside funds for a special reserve, it can reduce its taxable income by the amount contributed to the reserve by claiming a deduction according to the Income Tax Act.

Deduction under this section is allowed for an amount not exceeding 20% of the profits derived from eligible business computed under the head profits and gains of business or profession to a specified entity before making any deduction under this clause, carried to a special reserve account created and maintained by such specified entity.

If in the future, any amount is withdrawn from such special reserve then it shall be deemed to be the profits of business or profession and shall be chargeable to income tax as the income of the previous year in which such amount is withdrawn.

Calculation and Accounting Entries of Capital Redemption Reserve

Calculation of CRR

According to Section 55 of the Companies Act, 2013, a company limited by shares proposing to redeem its preference shares out of profits must transfer the sum equal to the nominal value of preference shares to be redeemed to a capital redemption reserve account. Hence,

The amount to be transferred to CRR = Nominal value of preference shares which are to be redeemed.

Accounting Entries of CRR

Difference between Capital Redemption Reserve and Other Reserves

Basis	Capital Redemption Reserve(CRR)	Other Reserves
Type	CRR is a special type of reserve created to account for the redemption or buyback of a company’s own shares.	Other reserves are created for various purposes and may serve different functions within a company.
Legal Requirement	Company law mandates the company limited by shares to create CRR during the redemption of preference shares.	These may be created voluntarily or as required by specific regulations or accounting standards.
Utilisation	The amount of CRR can be used to issue fully paid bonus shares to the members of the company. It is not allowed to be distributed to the shareholders.	It can be utilized for various purposes, such as meeting contingencies, funding future projects, absorbing losses or can be distributed as a dividend.
Disclosure	Company law requires specific disclosure in the financial statements regarding the purpose and utilization of this reserve.	The disclosure of the reserves may vary based on its nature, but there is generally a requirement to provide transparency in financial reporting.

Frequently Asked Questions (FAQs)

Is capital redemption reserve a capital reserve?

Yes, a capital redemption reserve has the nature of a capital reserve as it is not distributable as profit. It can not be treated as a revenue reserve.

Where can a company utilise the amount of capital redemption reserve?

A company may utilise the amount of capital redemption reserve for issuing bonus shares to its members.

Why capital redemption reserve is created?

It is created to protect the creditors and interest of shareholders and to maintain the financial stability of the company.

Can CRR be Transferred to Other Reserves?

Yes, CRR can be transferred to other reserves or utilized for specific purposes, such as covering premium costs, dividends, or other financial obligations.