SC Holds That Loss On Capital Reduction Is Allowable - Capital Reduction Akin To Extinguishment Or Relinquishment And Thus Results In Transfer Of Shares

FACTS OF THE CASE¹

• Jupiter Capital Pvt Ltd (‘Assessee') had acquired 15,33,40,900 shares having face value of INR 10 each in Asianet News Network Pvt Ltd (‘the Company'). The total share capital of the Company was 15,35,05,750 shares, resulting in Assessee's stake being 99.88% in the total paid up equity share capital of the Company.
• The Company had incurred losses and filed a petition before the Bombay HC for reduction of its share capital to set off the loss against the paid-up equity share capital.
• The Bombay HC ordered for a reduction in the share capital of the company from 15,35,05,750 shares to 10,000 shares. Accordingly, the shares of the Assessee were reduced proportionately from 15,33,40,900 shares to 9,988 shares having face value of INR 10 each. The Assessee continued to hold 99.88% in the share capital post reduction.
• Additionally, the Bombay HC also directed the Company for payment of INR 3.18 Crs to the Assessee as a consideration for capital reduction.
• The Assessee claimed long term capital loss on the reduction in share capital. However, the AO held that reduction in shares of the Company did not result in the transfer of a capital asset as envisaged in Section 2(47) of the Income Tax Act, 1961 (‘IT Act') considering that the face value of each share as well as the shareholding pattern remained the same.
• On further appeal by the Assessee, the CIT(A) upheld the order of AO. On further appeal by the Assessee, the Bangalore ITAT reversed the order passed by the CIT(A) and allowed the appeal filed by the Assessee relying on the decision of the SC in Kartikeya V. Sarabhai ² wherein there was no reference drawn to the percentage of shareholding prior to and post reduction of capital while holding that capital reduction amounts to transfer of shares.
• On further appeal by the Revenue in HC, the HC also upheld the order of the ITAT. The HC observed that even if the voting power of the Assessee had not changed, if the shares held by the Assessee were transferred at face value, the redeemable value would be INR 99,880 as compared to a higher amount on sale of shares held prior to capital reduction.
• Thereafter, the Revenue filed leave petition with Supreme Court

KEY OBSERVATIONS OF THE SUPREME COURT

• The SC, relying on the decision in Kartikeya V. Sarabhai (supra), observed the following:
  • Section 2(47) of the IT Act, which is an inclusive definition, inter alia, provides that relinquishment of an asset or extinguishment of any right therein amounts to a transfer of a capital asset.
  • While the taxpayer continues to remain a shareholder of the company even with the reduction of share capital, it could not be accepted that there was no extinguishment of any part of his right as a shareholder qua the company.
  • When as a result of the reducing of the face value of the share, the share capital is reduced, the right of the preference shareholder to the dividend or his share capital and the right to share in the distribution of the net assets upon liquidation is extinguished proportionately to the extent of reduction in the capital. Such a reduction of the right of the capital asset clearly amounts to a transfer within the meaning of section 2(47) of the IT Act.
• The SC referred to the decision in the case of Vania Silk Mills (P.) Ltd.¹ wherein it was held that the expression “extinguishment of any right therein” is of wide import. It covers every possible transaction which results in the destruction, annihilation, extinction, termination, cessation or cancellation, by satisfaction or otherwise, of all or any of the bundle of rights - qualitative or quantitative - which the assessee has in a capital asset, whether such asset is corporeal or incorporeal.
• The SC also reiterated that no reference was made to the percentage of shareholding prior to reduction of share capital and after reduction of share capital in the case of Kartikeya V. Sarabhai (supra).
• Further, the SC also referred to the decision in the case of Jaykrishna Harivallabhdas1, wherein it was clarified that receipt of some consideration in lieu of extinguishment of rights is not a condition precedent for the computation of capital gains.
• The Supreme Court also referred to the case of Anarkali Sarabhai ², wherein the Court held that both reduction of share capital and redemption of shares involve the purchase of its own shares by the company and hence will be included within the meaning of transfer under Section 2(47) of the IT Act.

AURTUS COMMENTS

• The decision is a welcome decision and puts to rest the litigation on relevance of shareholding percentage as a criteria for determining whether capital reduction constitutes a transfer. With this decision, both reduction in number of shares as well as reduction in the face value in course of capital reduction would constitute transfer of shares, thus triggering the computation of capital gains or loss. Further, a capital reduction shall constitute a transfer irrespective of whether the same involves payment of consideration or not.

Footnotes

1. PCIT vs. M/s. Jupiter Capital Pvt. Ltd. [SLP No. 63 of 2025]

2. Kartikeya V. Sarabhai v. Commissioner of Income Tax (1997) 7 SCC 524

1. CIT v. Vania Silk Mills (P.) Ltd. (1977) 107 ITR 300 (Guj)

1. CIT v. Jaykrishna Harivallabhdas (1998) 231 ITR 108 2Anarkali Sarabhai v. CIT (1997) 3 SCC 238

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