What is a Redeemable Preference Share? Explained

What is a Redeemable Preference Share?

A redeemable preference share is a type of preferred share issued by a company that includes an agreement to buy back or ‘redeem’ the shares from shareholders at a fixed price after a specified period. They provide a fixed rate of dividend and receive payment before equity shareholders, while generally not granting voting rights.  

How Redeemable Preference Shares Work

In the stock market, redeemable preference shares are a hybrid financial instrument that operate through a defined lifecycle, combining fixed returns with a planned exit for investors. 

• Issue stage: A company issues redeemable preference shares with specified terms such as dividend rate, tenure, and redemption conditions. 
• Holding period: During the tenure, investors receive dividends at a predetermined rate, subject to the company having distributable profits.
• Redemption: The company repays the share capital either at a fixed date, on a specific event, or at its option, as agreed at issuance.
• Source of repayment: Under Indian law, redemption must be funded either from profits available for dividend or through proceeds from a fresh issue of shares, ensuring capital stability.

Redeemable Preference Share Example

Let’s say, JXR Limited issues 10,000 redeemable preference shares of ₹120 each with a fixed dividend of 8% per annum and a redemption period of five years. 

Investors who subscribe to these shares receive ₹9.6 per share every year as a dividend, subject to the company having sufficient profits.

At the end of five years, the company repays the original ₹120 per share to the investors, either out of its accumulated profits or by raising fresh capital, as required under the Companies Act, 2013.

Key Features of Redeemable Preference Shares

Here are the key features of redeemable preference shares:

• Defined maturity/redemption date: These shares are issued for a specified tenure, after which the company is obligated to redeem them as per agreed terms.
• Fixed rate of dividend: Preference shareholders are entitled to a pre-decided dividend, which is paid prior to any distribution to equity holders. 
• Repayment at par or premium: The company repays the shares either at their nominal value or at a premium, based on the terms agreed at issuance. 
• Priority on winding up: During liquidation, preference shareholders are repaid before equity shareholders for the amount they have invested. 

Methods of Redemption (Out of Profits vs Fresh Issue)

Under Indian company law, redeemable preference shares can be repaid only through two recognised methods, each designed to protect the company’s capital base and creditor interests. 

Criteria	Redemption Out of Profits	Redemption Through Fresh Issue
Source of funds	Paid out using distributable profits of the company.	Paid using proceeds from issuing new shares
Impact on reserves	Requires transfer to Capital Redemption Reserve	No impact on reserves
Capital structure	Maintains capital by creating reserve	Maintains capital by replacing old shares with new
Cash flow impact	Uses internal funds, may affect liquidity	Preserves internal cash, no immediate strain
Compliance requirement	Mandatory reserve creation equal to nominal value redeemed	No reserve required if fresh issue is used
Financial flexibility	Depends on profitability and available reserves	Depends on ability to raise new capital

Time Limit for Redemption (India Rules)

In India, the issuance and redemption period of preference shares is regulated under Section 55 of the Companies Act, 2013. 

• Maximum tenure: These shares are required to be repaid within a period not exceeding 20 years from the date of issue, as per Section 55 of the Companies Act, 2013. 
• Infrastructure exception: Infrastructure companies can issue for longer durations with phased redemption.
• Mandatory redemption: Irredeemable preference shares are not allowed in India.

Advantages of Redeemable Preference Shares

These shares offer a balanced financing option, combining predictable investor returns with flexibility for companies. 

• No immediate cash burden: The company does not need to use internal funds for redemption, preserving liquidity for operations and growth.
• Possibility of raising funds at a premium: New equity shares can be issued at a premium, helping the company bring in additional capital beyond face value.
• Continuity of capital base: The overall share capital remains intact as old preference shares are replaced with new equity shares.
• Improved financial flexibility: The company can manage redemption without impacting retained earnings or reserves.

Disadvantages of Redeemable Preference Shares

Besides all the advantages, the shares come with the following disadvantages:

• Obligation to redeem within a fixed period: Companies are legally required to repay these shares within a specified timeframe, creating financial pressure in case of weak cash flows.
• Fixed dividend commitment: Even though dividends depend on profits, which can strain earnings during low-profit periods. 
• No tax advantage on dividends: Dividend payments on preference shares cannot be claimed as a tax deduction, which can raise the overall cost of financing. 
• Potential dilution on fresh issue redemption: If redemption is carried out through a fresh issue of equity shares, it can dilute future earnings per share and alter ownership patterns.

Why Do Companies Issue Redeemable Preference Shares?

The companies issue redeemable preference shares to secure funding for a fixed duration, without making a lasting change to ownership structure. They also help in maintaining a balance in the capital structure while avoiding immediate cash outflow pressures. 

Are Redeemable Preference Shares Good for Investors?

Redeemable preference shares can suit investors who prefer stable income with relatively lower risk than equity. However, they do not participate in company growth beyond the fixed return.

In stock analysis for beginners, these shares are often viewed as income-oriented instruments, helping investors understand how different securities offer varying risk-return trade-offs within a portfolio. 

Taxation of Preference Shares in India

The preference shares in India are taxed based on dividend income and capital gains arising from sale or redemption. 

The dividends are taxed as per at applicable slab rates of the shareholders under the Income-tax Act, 1961. 

The following table discusses the capital gains taxation where listed preference shares qualify as long-term after 12 months, and unlisted preference shares require a 24-month holding period to be treated as long-term.  

Asset type	Holding period	Short-term capital gains	Long-term capital gains
Listed shares	12 months	20%	12.5% over ₹1.25/year, without indexation
Unlisted shares	24 months	Tax at slab rates	12.5% without indexation

Conclusion 

Redeemable preference shares serve as a practical financing tool that balances investor returns with corporate flexibility. They offer fixed income, priority claims, and a defined exit, making them distinct from both equity and debt instruments.

For companies, they offer a way to secure funding with a built-in repayment plan, keeping long-term ownership unchanged. For investors, they offer predictable returns, though with limited upside. Analysing these shares provides useful insight into capital structure and broader investment choices. 

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