Redemption of Preference Shares: Rules and Conditions Under Companies Act, 2013

Key takeaways

• Section 55 of the Companies Act, 2013 prohibits Indian companies from issuing irredeemable preference shares. Every preference share issued after 1 April 2014 must carry a defined redemption tenure not exceeding 20 years.
• Preference shares can only be redeemed if they are fully paid. Partly paid shares must be called up before redemption proceeds.
• Redemption must be funded either out of distributable profits or out of the proceeds of a fresh share issue made for that purpose. No other funding source is permitted.
• When redemption is funded from profits, an amount equal to the nominal value of the redeemed shares must be transferred to the Capital Redemption Reserve Account (CRR). The CRR cannot be distributed as dividend but can be used to issue fully paid bonus shares.
• Any premium payable on redemption must generally be funded from profits for companies complying with Section 133 accounting standards. Other companies may also use the securities premium account.
• The step-by-step procedure for redemption of preference shares involves a board resolution, individual notification to shareholders, payment, a Register of Members update, and Form SH-7 filing with the ROC within 30 days.
• If the company cannot redeem, it may approach the NCLT under Section 55(3) with consent from holders of three-fourths in value of the unredeemed preference shares, to issue further redeemable preference shares in place of the original ones. Dissenters must be redeemed immediately by Tribunal order.
• The Supreme Court confirmed in 2025 that an unredeemed preference shareholder does not become a financial creditor and cannot initiate IBC proceedings against the company.
• On redemption, the investor's gain is subject to capital gains tax. For unlisted shares held over 24 months (transfers on or after 23 July 2024), long-term capital gains tax applies at 12.5% without indexation.

Every preference share issued by an Indian company must, by law, be redeemable. Section 55(1) of the Companies Act, 2013 prohibits companies limited by shares from issuing irredeemable preference shares.

Redemption, in this context, means the company repurchases and cancels its preference shares by returning the capital to shareholders, either on a fixed date, on the occurrence of a specified event, or within the period agreed at the time of issue. 

Unlike a secondary sale, the shares are not transferred to another party; they are redeemed by the company, and the company's issued preference share capital is reduced by their nominal value.

Redemption of preference shares as per Section 55 of the Companies Act, 2013

Section 55 of the Companies Act, 2013 sets out the complete framework for both issuing and redeeming preference shares. It applies to all companies limited by shares and has been effective from 1 April 2014.

The detailed requirements sit in Rule 9 and Rule 10 of the Companies (Share Capital and Debentures) Rules, 2014, which prescribe what must be disclosed at the time of issue, the permitted modes of redemption, and the conditions under which an infrastructure company may exceed the 20-year tenure.

Conditions that must be satisfied before redemption of preference shares

Section 55(2) imposes three preconditions. Each must be met; there is no provision for partial compliance.

a. The shares must be fully paid up. Partly paid preference shares cannot be redeemed. If any calls remain outstanding on the shares to be redeemed, the company must first make a final call and collect the outstanding amounts before proceeding.

b. The shares must be redeemed within the permitted tenure. Preference shares must be redeemed within 20 years of their date of issue (except in case of infrastructure projects). 

c. Redemption must be funded from one of the two permitted sources. These are distributable profits or the proceeds of a fresh issue of shares made for the purpose of redemption. No other funding source is permitted. This is addressed in the section below.

How redemption of preference shares can be funded: profits and fresh issue

Section 55(2) permits only two sources of funds for redemption. 

a. Out of distributable profits. The company may redeem preference shares out of profits that would otherwise have been available for dividend. When this route is used, the company must simultaneously transfer a sum equal to the nominal value of the shares being redeemed to a reserve called the Capital Redemption Reserve Account. This transfer is mandatory and is not at the board's discretion.

b. Out of the proceeds of a fresh issue of shares made for the purpose of redemption. The company may issue new shares, whether equity or preference, and use those proceeds to fund the redemption. When this route is used, no transfer to the Capital Redemption Reserve is required, because the share capital being retired is effectively replaced by the new issue.

The Capital Redemption Reserve Account: what it is and why it exists

When preference shares are redeemed out of profits rather than a fresh issue, the company's share capital decreases but its total funds decrease by the same amount. Left unaddressed, this reduces the capital base available to creditors.

The Capital Redemption Reserve Account solves this by locking away an amount of distributable profits equal to the nominal value of the shares redeemed. The CRR is treated, for the purposes of the Companies Act, as if it were paid-up share capital, meaning it cannot be distributed as dividend. It can, however, be used for one specific purpose: paying up unissued shares of the company as fully paid bonus shares, as permitted under Section 55(4). 

Redemption at a premium: which funding source applies

Preference shares are frequently issued with a redemption premium, meaning the shareholder receives more than the face value of the shares on redemption. Which source funds that premium depends on the category of the company.

• For companies whose financial statements comply with the accounting standards prescribed under Section 133 of the Companies Act (companies following Ind AS or AS), the premium payable on redemption must be provided out of the company's profits before the shares are redeemed. The securities premium account may not be used for this purpose in such companies. 
• For all other companies, and for preference shares issued before the commencement of the 2013 Act by any company, the premium on redemption may be provided out of either profits or the securities premium account.

The practical implication: founders should verify which accounting standard regime applies to their company before structuring the redemption premium terms at the point of issue, because the source of funds available at redemption is determined by accounting compliance status, not by agreement.

Step-by-step redemption procedure for preference shares

The procedure below applies to a private limited company redeeming non-listed preference shares out of profits. Listed companies with preference shares on a recognised exchange must additionally comply with Regulation 60 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, which requires fixing a record date.

Step 1: Verify preconditions

Confirm that the shares are fully paid, that the redemption date or trigger event specified in the terms has occurred or is imminent, and that there are no subsisting defaults on prior preference shares or dividends. 

Step 2: Board meeting

Issue notice to all directors at least seven days before the meeting. At the board meeting, pass a resolution approving the redemption, specifying whether it is to be funded from profits, a fresh issue, or a combination. 

If redemption is out of profits, the resolution must also approve the transfer of the nominal value of the redeemed shares to the Capital Redemption Reserve Account. 

Step 3: Notify preference shareholders

Individually inform each preference shareholder of the proposed redemption, the redemption amount, any premium payable, and the payment date. The terms of redemption must match those agreed at the time of issue or as subsequently varied with shareholder approval under Section 48.

Step 4: Make payment to preference shareholders

Pay the redemption amount (nominal value plus any agreed premium) to each preference shareholder. Payment should be through banking channels and documented.

Step 5: Update the Register of Members

Make the necessary entries in the Register of Members maintained in Form MGT-1 within seven days of the board meeting at which the redemption was approved, reflecting the cancellation of the redeemed shares.

Step 6: File Form SH-7 with the Registrar of Companies

Under Section 64(1) of the Companies Act, 2013, the company must file a notice with the Registrar within 30 days of the redemption in Form SH-7. Attach a certified true copy of the board resolution authorising the redemption, and the altered AoA if the articles were amended. The filing records the reduction in the company's preference share capital.

When the company cannot redeem preference shares on the agreed terms: the Section 55(3) route

A company may find itself unable to redeem preference shares on the agreed date because it has neither sufficient distributable profits nor the capacity to issue fresh shares. Section 55(3) provides a route that avoids the company being in outright breach of its redemption obligation.

The company may, with the consent of the holders of three-fourths in value of such preference shares (not three-fourths of shareholders by number; the threshold is calculated on the nominal value of shares held), petition the National Company Law Tribunal (NCLT) for approval to issue further redeemable preference shares. The new shares are issued in an amount equal to the total amount due, including any accrued dividend, on the unredeemed shares. On the issue of these new preference shares, the original unredeemed shares are deemed to have been redeemed.

The petition must be filed with the NCLT in Form NCLT-1, with the documents specified in Annexure-B to the NCLT Rules and the prescribed filing fee.

One critical safeguard: the NCLT is required, when granting approval under Section 55(3), to simultaneously order the immediate redemption of shares held by any preference shareholders who did not consent to the issue of further redeemable preference shares. Dissenters cannot be forced into an extended instrument; they must be paid out.

Unredeemed preference shares and the IBC: the Supreme Court's position

A question that has gained significant practical relevance for startups and investors is whether a preference shareholder whose redemption date has passed, but who has not been paid, can initiate insolvency proceedings against the company under the Insolvency and Bankruptcy Code, 2016 (IBC).

The Supreme Court addressed this directly in EPC Constructions India Limited v. Matix Fertilizers and Chemicals Limited, a judgment upheld through multiple appellate stages and confirmed in 2025. The court held that redeemable preference shares remain part of the company's share capital, not debt, and that the failure to redeem on the due date does not transform the shareholder's position into that of a financial creditor under the IBC. A Section 7 petition, the route available to financial creditors, cannot be used by a preference shareholder whose redemption is overdue.

The court's reasoning followed the statutory structure of Section 55 directly: because redemption is only possible out of distributable profits or fresh issue proceeds, a company without either cannot be said to be in default in the same sense as a debt obligation where no such conditionality applies. The redemption obligation is not unconditional; it is conditional on the availability of the permitted funding sources.

Tax treatment of redemption proceeds for the preference shareholder

Redemption of preference shares constitutes a transfer of a capital asset under the Income Tax Act, 1961, and the proceeds are therefore subject to capital gains tax. The gain is calculated as the difference between the redemption amount received, including any premium, and the cost of acquisition of the shares.

Holding period and tax rate. For preference shares listed on a recognised stock exchange in India, the holding period for classification as a long-term capital asset is more than 12 months. For unlisted preference shares, which covers the vast majority of preference shares held by private equity and venture capital investors in Indian startups, the Finance (No. 2) Act, 2024 reduced the long-term threshold: assets transferred on or after 23 July 2024 are long-term if held for more than 24 months, down from the earlier 36-month threshold.

Long-term capital gains on unlisted preference shares are taxed at 12.5% without the benefit of indexation, following the amendments introduced in Finance (No. 2) Act, 2024. Short-term gains are taxed at the applicable income tax slab rate. The premium received on redemption is included in the redemption proceeds and is subject to capital gains treatment, not income from other sources. 

Founders should note that the tax treatment described above applies to the investor. The company's obligation, specifically which fund source must be used to pay the premium, is governed entirely by Section 55(2)(d) of the Companies Act.

FAQs on redemption of preference shares

What is the time limit for redemption of preference shares?

Under Section 55(2) of the Companies Act, 2013, preference shares must be redeemed within 20 years from the date of their issue. The redemption date or trigger events must be specified in the terms of redemption, as required by Rule 9(3)(h) of the Companies (Share Capital and Debentures) Rules, 2014. One exception applies: companies issuing preference shares for infrastructure projects as defined in Schedule VI of the Act may issue shares with a tenure exceeding 20 years, subject to mandatory annual redemption of a minimum percentage of such shares at the option of the shareholder from the 21st year onward.

What happens when you redeem preference shares?

When preference shares are redeemed, the company pays the redemption amount, being the nominal value plus any agreed premium, to the preference shareholders, and the shares are cancelled. The company's issued preference share capital decreases by the nominal value of the redeemed shares. If the redemption is funded from distributable profits, an equivalent amount must be transferred to the Capital Redemption Reserve Account (CRR), a statutory reserve that cannot be distributed as dividend but can be used to issue fully paid bonus shares. If funded from the proceeds of a fresh share issue, no CRR transfer is required. The company must update its Register of Members and file Form SH-7 with the Registrar of Companies within 30 days of redemption.