When a company raises funds through the issue of debentures, the terms under which these are issued can significantly impact its financial structure. One such term is the premium on issue of debenture. This financial element plays a crucial role in the accounting and tax treatment for the company. It reflects an amount received over and above the face value of the debenture, signifying investor confidence and financial leverage. Understanding how this premium is treated, reported, and utilized is essential for both corporate finance professionals and stakeholders evaluating the company’s financial health.
Understanding Premium on Issue of Debenture
What is a Debenture?
A debenture is a type of long-term debt instrument issued by a company to borrow money. It is not backed by any collateral but rather the creditworthiness and reputation of the issuer. Companies use debentures to meet capital requirements for expansion, new projects, or debt refinancing.
Issuing at a Premium
When a debenture is issued at a price higher than its face or par value, the difference is referred to as the premium. For example, if a debenture with a face value of ₹1,000 is issued for ₹1,050, the ₹50 excess is the premium on issue. This premium reflects the market’s favorable perception of the company’s financial stability and future prospects.
For the Company, Premium on Issue of Debenture is a…
Capital Receipt
From the company’s perspective, the premium on the issue of debenture is considered a capital receipt. This means it is not earned through the company’s core operating activities and does not represent a part of its normal business income. It is treated differently from revenue receipts in accounting and taxation.
Part of Securities Premium Reserve
The premium received is credited to a special account known as the Securities Premium Reserve. This reserve is shown under the head of Reserves and Surplus in the liabilities side of the balance sheet. It cannot be treated as income or distributed as dividends to shareholders. Instead, it must be used for specific purposes as per the Companies Act.
Accounting Treatment
Journal Entry at the Time of Issue
When a debenture is issued at a premium, the accounting entry reflects both the face value and the premium separately. Here’s how it’s recorded:
Bank A/c Dr. ₹1,050 To Debenture A/c ₹1,000 To Securities Premium A/c ₹50
In this entry, the bank account is debited with the total money received, while the face value is credited to the debenture account and the premium is credited to the securities premium account.
Treatment in Financial Statements
- Balance Sheet: The premium is shown under Reserves and Surplus as Securities Premium.
- Profit & Loss Statement: The premium does not affect the income statement as it is not part of the operational revenue or expenses.
Utilization of Securities Premium
Legal Constraints
The usage of funds in the securities premium reserve is restricted under law. In many jurisdictions, including under the Indian Companies Act, 2013, these funds can only be utilized for specific purposes.
Permissible Uses
- Issuing fully paid bonus shares to existing shareholders
- Writing off preliminary expenses of the company
- Writing off expenses, commission, or discount on the issue of shares or debentures
- Providing premium payable on redemption of debentures or preference shares
- Buying back shares as permitted by the law
Impact on the Company’s Financial Position
Strengthens the Reserve Base
The addition of premium funds increases the reserve base of the company, which can improve financial ratios and make the balance sheet more attractive to investors and lenders.
Non-Dilutive Financing
By issuing debentures rather than equity, companies raise capital without diluting ownership. The premium enhances this further by generating additional funds without increasing debt obligations proportionately.
Perception of Stability
Receiving a premium indicates that investors are willing to pay more for the company’s securities, signaling strong market trust. This enhances the company’s reputation in capital markets.
Comparison: Premium vs Discount on Issue of Debenture
Issue at Premium
- Investor pays more than the face value
- Company receives additional capital
- Premium credited to Securities Premium Reserve
Issue at Discount
- Investor pays less than the face value
- Company receives less than the nominal amount
- Discount recorded as a loss or deferred revenue expenditure
Tax Implications
For the Company
The premium received is not considered income for tax purposes and hence not taxable. However, the funds must be used strictly for the permitted purposes to maintain their tax-exempt status.
For Investors
The premium has no direct tax implication on investors at the time of purchase. However, it may affect the capital gains calculation when the debentures are sold or redeemed.
Strategic Considerations
Why Issue Debentures at a Premium?
- To improve cash inflow without increasing liabilities proportionately
- To reflect the strong financial position of the company
- To enhance the company’s image among lenders and rating agencies
When Not to Issue at a Premium
- In a bearish or uncertain market where investors are unwilling to pay more than face value
- If the company has a weak credit rating or financial instability
For the company, premium on issue of debenture is a capital receipt that contributes to the securities premium reserve and reflects financial strength. It is not part of income but plays a vital role in strengthening reserves, improving market perception, and maintaining financial flexibility. Proper accounting and legal compliance ensure that this fund becomes a valuable tool for strategic growth, rather than just an accounting entry. Companies aiming to attract sophisticated investors often leverage the ability to issue debentures at a premium to signal stability and long-term value. Therefore, understanding the implications of debenture premiums is essential for robust corporate financial management.