Note on Reduction of capital


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Note on Reduction of capital

  1. 1. Taxpert Professionals || www.taxpertpro.comReduction of Capital 1This is the brief note regarding reduction of share capital to be used as a way ofpaying back the shareholders. In case of Foreign direct investment the companieslook for the way of taking the capital invested in India back to the home country. Oneof the options available to the company is to reduce the share capital of Indiancompany and paying the shareholders. In this note we have analyzed and discussedthe provisions of laws applicable in India to reduction of capital.1. INTRODUCTIONThe need of reducing capital may arise in various circumstances, for example, accumulatedbusiness losses, assets of reduced or doubtful value, etc. As a result, the original capital may eitherhave become lost or a company may find that it has more resources that it can profitably employ.In either of these cases, the need may arise to adjust the relation between capital and assets.2. REDUCTION OF CAPITAL?Reduction of Capital is governed by Section 100 of the companies Act, 1956. It means reduction ofissued, subscribed and paid-up capital of the company. Reduction of share capital may be effectedin the following ways: 1. In respect of share capital not paid-up, extinguishing or reducing the liability on any of its shares. 2. Cancel any paid-up share capital, which is lost, or is not represented by available assets. This may be done either with or without extinguishing or reducing liability on any of its Shares 3. Pay off the paid-up share capital, which is in excess of the needs of the company. This may be achieved either with or without extinguishing or reducing liability on any of its shares. All the above including repayment of capital requires prior sanction of Court. In other words, there can be no retrospective approval for reduction of share capital.3. IMPLICATIONS UNDER COMPANIES ACT3.1 Power of the company for reduction of share capitalFor a company to reduce its share capital, it should have the power under its Articles of Associationto do so. [Section 100]3.2 Modes of reduction of share capitalThe Act does not prescribe the manner in which the reduction of capital is to be effected nor isthere any limitation of the power of the Court to confirm the reduction except that it must be firstbe satisfied that all creditors entitled to object to the reduction have either consented to the saidreduction or that they should be paid off or their interest secured. (British and American Trusteeand Finance Corp. vs. Couper (1894) AC 399)Reduction of capital in the following ways is permissible under the Act:
  2. 2. Taxpert Professionals || 2 1. Diminishing the nominal amount of the share so as to leave a less sum unpaid; 2. Diminishing the nominal amount of any shares by writing off or repaying paid-up capital; 3. Diminishing the nominal amount by combining both (1) and (2); 4. Diminishing the number of shares by extinguishing the existing liability on certain shares, writing off or repaying the whole amount paid-up thereon, and cancelling them.4. PROCEDURAL ASPECTS AS PER COMPANIES ACT4.1 Special ResolutionThis is the first and main requirement for the reduction of share capital. Unless a special resolution,as authorised by the articles, is passed for reduction of the share capital, a company cannot effectshare reduction.4.2 Court SanctionNext step for the Reduction of Share Capital is to secure the sanction of the Court for reduction.Before confirming the reduction the Court shall be satisfied that the • consent of the creditors to the reduction has been obtained or • the creditors have been discharged or • their debts or claims have been discharged or Special resolution and prior settled or secured. approval from court is required for(The ‘creditor’ for this purpose means a person who has reduction of capitala debt or any claim against the company of such anature as would have been provable in winding up.) • As per section 102, the Court has first to be satisfied that the creditors who had objected to the reduction that either their consent to the reduction has been obtained or their debts or claims have been discharged or settled or secured. • If the company does not admit or provide the full amount of debt or the amount is contingent or not ascertainable then the Court has the right to fix the amount. • Under the special circumstances and if the Court thinks it proper then it has the power to dispense with the provisions of securing the debts of the creditors as mentioned above. • In other cases the creditors can object only with the consent of the Tribunal.4.3 Court confirming reduction and power on making such orderThe Court may direct the company that the words "and reduced" be added to the Company’s namefor a specified period, and that the Company must publish the reasons for reduction of share capitaland also the causes which led to it, with a view to giving proper information to the public.4.4 Registration & Minute of Reduction • As per section 103(4) minutes with a copy of the order has to be registered with the Registrar of the Companies and according to that Registrar of Companies will issue Certificate under his hand or authenticated by his seal.
  3. 3. Taxpert Professionals || 3 • Once the minutes get registered it shall be deemed to be substituted for the corresponding part of the memorandum of the company, and shall be valid and alterable as if had been originally contained therein. The substitution of any such minute as aforesaid for part of the memorandum of the company shall be deemed to be an alteration of the memorandum within the meaning and for the purpose of section 40.4.5 Liability of Members and Penalty • On the reduction of share capital, the extent of liability of any past or present member on any call or contribution shall not exceed the difference between the amount paid on the share, or the reduced amount, if any, which is to be deemed to have been paid thereon, by the member, and the amount of the shares fixed by the scheme of reduction. • If, however any creditor entitled to object to the reduction of share capital is not entered in the list of creditors by reason of his ignorance of the proceedings for reduction and after the reduction, the company is unable to pay his debt or claim then every person who was member at the time of the registration of the order and minutes of the reduction will be liable to contribute for the payment of the debt of the creditor. • If any officer of the company, who conceals the name of the creditor or misrepresents the nature of the debt or claim of the creditor who is entitled to object to the reduction of the share capital as per the provisions of section 105.6. IMPLICATIONS UNDER INCOME-TAX ACT, 1961 Reduction in share capital is(‘IT ACT’) taxed as Dividend to theWhen any company reduces the share capital as per the extent of accumulated profitsprovisions of the Companies Act, 1956 by way of reducingthe face value of shares or by way of paying off part of and distribution attributablethe share capital, it amounts to extinguishments of the to capital will be subject torights of the member to the extent of reduction of facevalue of share capital and therefore it is treated as Capital Gain.transfer under sec. 2(47) of the IT Act. The amountreceived is liable to capital gain tax u/s. 45 of the IT Act.There are two aspects involved in the taxability of the income received on reduction of capital inthe hands of the shareholders of the company • Amounts distributed by the company on reduction of share capital to the shareholders attributable to accumulated profits will be considered as deemed dividend u/s. 2(22)(d) and will be chargeable accordingly, and, • Distribution attributable to capital will be subject to capital gains tax u/s. 45.Only the distribution, which is over and above the accumulated profits, can be treated as capitalreceipts in the hands of shareholder and only when the capital receipt is in excess of original cost ofacquisition of that interest which stands extinguished, capital gains will arise to the shareholder.This is supported by the following case laws: • Kartikeya V. Sarabhai vs. CIT, 228 ITR 163 (SC),It is held in this case that even if there is reduction in the face value of the shares and consequentpayment by the company to the shareholder towards such reduction, the transaction results inextinguishments of right in the shares held by the shareholder. Consequently, the reduction of theshare capital would be eligible to capital gains. The Supreme Court has referred the decision in thematter of Anarkali Sarabhai vs. CIT (SC), 224 ITR 422 in which case preference shares were
  4. 4. Taxpert Professionals || 4redeemed in entirety whereas in the present case it was partly redeemed by reduction of sharecapital, therefore the analogy is same.============================================================= For further information get in touch with us at Contact us at 09769134554 || 009769033172=============================================================