Introduction
The Supreme Court recently in Jupiter Capital[1] upheld the ruling of Bombay High Court that the complete reduction of capital (resulting in cancellation of shares) would be tantamount to transfer in terms of Section 2(47) of the Income Tax Act, 1961 (‘IT Act’) and the consequent payout would be exigible to tax under the head capital gains. As a corollary, the resultant loss incurred by the taxpayer was allowed to be claimed. The Supreme Court decision is a welcome one, in re-assuring the taxpayer’s right to claim capital loss arising from capital reduction especially in a scenario where a payout is received.
However, it should be noted that the Special Bench of the Mumbai Tribunal in Bennett Coleman[2] dealt with an issue of whether pursuant to a scheme of capital reduction by way of reduction in face value and where no payout was received by the taxpayer, the said transaction would be subject to income-tax under the head ‘Capital gains’. In that case, the Tribunal at the outset held that there was no transfer. Further, placing reliance in the decision of the Hon’ble Supreme Court in B C Srinivasa Shetty[3], it was held that absent any payout, the computation mechanism would in any case fail and therefore, the transaction would not be subject to income-tax under the head ‘Capital gain’. Consequently, no loss was allowed to be set off and carried forward by the taxpayer.
In this backdrop, the article attempts to explore the possible fate of taxpayers to claim capital loss in a scenario where no payout is received pursuant to a reduction in share capital.
Extinguishment of rights vide reduction of share capital amounts to ‘transfer’
Section 2(47) of the IT Act defines ‘transfer’ to interalia include (a) any sale, exchange or relinquishment of the capital asset or (b) extinguishment of any rights therein.
The Hon’ble Supreme Court in Kartikeya V. Sarabhai[4] dealt with an issue of whether reduction in face value of shares without reduction in number of shares will amount to transfer within the meaning of Section 2(47) of the IT Act and consequently, whether the payout received by the taxpayer is exigible to income tax under the head ‘Capital gains’. In the said case, it was observed that upon reduction in face value of shares, the taxpayers’ voting rights as well as dividend receivable stood extinguished proportionately in terms of Section 87 of the Companies Act, 1956[5]. The Hon’ble Supreme Court observed that ‘transfer’ under Section 2(47) not only includes sale of a capital asset but also includes relinquishment or extinguishment of any rights over such asset. Therefore, it was held that such a reduction of the right in the capital asset as a result of reduction in face value of shares clearly amounts to a transfer within the meaning of Section 2(47) IT Act. Consequently, the resultant gains in the hands of the taxpayer were subject to income tax as ‘capital gains’. The aforesaid decision of the Hon’ble Supreme Court was followed in another decision of the Court in G. Narasimhan[6] wherein a similar proposition was laid down. It is interesting to note that even in the said case, the taxpayer received a payout in connection with the capital reduction.
It can be understood from the above decisions that in cases where it can be ascertained that rights of the taxpayer stand extinguished pursuant to a capital reduction and a payout is received, capital loss of the taxpayer can be carried forward.
Moving forward, the relevance of existence of a payout and the manner of effecting capital reduction will be discussed in the ensuing paragraphs.
Face value reduction without payout
The charging section for ‘Capital gains’ under the IT Act is provided in Section 45 wherein any profits or gains arising from the transfer of a capital asset is chargeable to income tax under the head ‘Capital gains’. Further, the mode of computing the income chargeable to income-tax under the head ‘Capital Gains’ is provided in Section 48 in terms of which the income chargeable under Section 45 is computed by reducing the cost of acquisition (‘COA’) of an asset from the full value of consideration (payout received) received on transfer of capital asset. Therefore, the essential ingredients for charging of income under Section 45(1), are (a) transfer of a capital asst, (b) determinable consideration accruing on such transfer, and (c) determinable COA for such transfer. In terms of the principle laid down by the Hon’ble Supreme Court in B.C. Srinivasa Setty[7], if any one of the essential ingredients fails, the levy would fail.
With the recent decision of the Supreme Court, the law with respect to taxability of income under the head ‘Capital Gains’ is settled in scenarios where a payout is received by the taxpayer on a complete capital reduction (other than face value reduction). However, in Bennett Coleman the Special Bench of the Mumbai ITAT held the taxpayer cannot claim capital loss on reduction of face value of shares for the below mentioned reasons;
- Even after the capital reduction the percentage of shareholding of the taxpayer in the investee entity remained the same. The loss suffered by the taxpayer was in respect of the investment made by the taxpayer. For the loss to be allowable as ‘capital loss’ the conditions under Section 2(47) should stand satisfied. However, in the present case, unlike in Kartikeya V. Sarabhai the voting rights/share of net worth of the shareholder remained the same vis-à-vis other shareholders. There is no change in the intrinsic value of the shares. Therefore, no rights in the capital assets stood extinguished before and after the capital reduction.
- It was observed that wherever Legislature intended to substitute the cost of acquisition at zero, specific amendment has been made. In the absence of such amendment it has to be inferred that in the case of reduction of shares, without any apparent consideration, that too in a situation where the reduction has no effect on the right of shareholder with reference to the intrinsic rights on the company, it is always possible to argue that cost of acquisition and full value of consideration cannot be ascertained. Accordingly, relying on the ratio laid down in C. Srinivasa Setty, it was held that the transaction would be outside the ambit of tax net and that no capital loss would be allowed to be claimed by the taxpayer.
In this backdrop, it is relevant to note that the case in B.C. Srinivasa Setty related to transfer of a business undertaking which includes liabilities, unrecorded assets, etc., for which the COA cannot be reasonably determined. It was in this context that the Supreme Court held that when COA is not determinable, the levy would fail. It is worthy to note that the factual matrix in which the judgment of B.C. Srinivasa Setty insofar as not being able to determine cost of acquisition in a business transfer is entirely distinct to a case of capital reduction. In a capital reduction (especially reduction of face value) without payout one cannot say that cost of acquisition/full value of consideration is not determinable; the reason being, in such cases, the full value of consideration is actually ‘Nil/zero” since there is no payout and the cost of acquisition will be = Original cost * the percentage of face value reduction.
In a recent case of Tata Sons Limited[8] the Mumbai ITAT dealt with a case wherein no payout was received by the taxpayer pursuant to a capital reduction by cancellation of equity shares. The ITAT distinguished the Special Bench decision in Bennet Coleman and further held that the principle laid down in B.C. Srinivasa Setty will have no role to play in cases where the COA or FVC is conceivable or ascertainable but is ‘Nil’. Further, reliance was placed in the decision of the Gujarat High Court in Jaykrishna Harivallabhdas[9] wherein it was held that where no payout was received by the taxpayer on liquidation of the investee company, the taxpayer was allowed to claim the capital loss under Section 46(2) read with Section 48. In Jaykrishna Harivallabhdas the High Court refuted the argument advanced by the Revenue insofar as stating that where no payout is received the loss arising therefrom is not allowable since, the language employed in Section 46(2) deems the ‘money received’ less dividend as the full value consideration. The High Court held that the in order to bring the deeming fiction envisaged under Section 46(2) to a logical end, even in cases of Nil Consideration, the provision should apply.
Therefore, even in a case where no payout is received pursuant to a share cancellation, Tata Sons Limited and with the strength of Jaykrishna Harivallabhdas will hold ground and be of some relief to taxpayers in claiming the capital loss arising from such transaction.
However, with respect to capital reduction through reduction of face value, despite the decision of Kartikeya Sarabai holding that even instances of face value reduction constitutes transfer, the decision of Bennet Coleman appears to have opened the pandoras box again. The fundamental question that needs to be answered by higher Courts in this matter is whether at all the shareholder loses any rights where capital reduction is carried out by merely lowering the face value.
Deeming fiction under Section 50CA
Though the present judgment has not discussed the impact of Section 50CA, in light of the above discussion regarding the interplay of Nil consideration and charge under the head ‘capital gains’, it is worthy to explore how the situation will play out where a deeming provision is in place.
Where the capital asset is an unquoted share which is subject to capital reduction, Section 50CA stipulates what should be adopted as the full value of consideration notwithstanding that the actual consideration is a lesser value. A question that arises here is whether a taxpayer can argue that the said deeming provision should not apply where no consideration is received and whether such an argument would be contrary to the position taken that cases of no payout would also be subject to tax under the head capital gains.
Further, in the case of capital reduction through face value, the question which arises for consideration is whether the provisions of 50CA will come into play. In this regard, it is relevant to note that under 50CA the full value of consideration is compared with the fair market value of share on the date of transfer. In other words, the full value of consideration is compared with the value which the shares would otherwise fetch when it is sold in the open market. Considering the same, it is plausible for one to argue that Section 50CA will apply only if the shares are transferred in its entirety. It will not apply to transfer (extinguishment) of some rights in shares.
[The author is an Associate in Direct Tax Team at Lakshmikumaran & Sridharan Attorneys, Chennai]
[1] [2025] 170 taxmann.com 305 (SC) – SLP filed by Revenue against Bom HC judgment dismissed.
[2] [2011] 12 ITR (T) 97 (Mumbai)
[3] [1981] 128 ITR 294 (SC)
[4] (1997) 7 SCC 524
[5] Corresponding to Section 47(2) of the Companies Act, 2013
[6] [1999] 236 ITR 327 (SC)
[7] [1981] 128 ITR 294 (SC)
[8] [2024] 158 taxmann.com 601 (Mumbai - Trib.)
[9] [1998] 231 ITR 108 (Gujarat HC)
