CASE LAW: Reduction of Share Capital by way of cancellation of Shares amounts to “Transfer” and Losses available for set-off

Recently, the Mumbai bench of the Income Tax Appellate Tribunal in the case of Tata Sons Limited held that the reduction of share capital of the company by way of cancellation of shares is an extinguishment of rights in shares and be treated as “transfer”.

Facts of the case

• As on 01/04/2008, the assessee was holder of 288,13,17,286 equity shares in Tata Tele-Services Company Ltd. (TTSL) acquired at various points of time.
• Because of substantial loss, TTSL announced a Scheme of Capital reduction whereby the paid-up equity share capital of TTSL was to be reduced by way of reduction of the number of equity shares of the company of Rs. 10/- each from 634,71,52,316 shares to 317,35,76,158 shares; by reducing the said amount from the accumulated debit balance in the Profit & Loss Account and by reduction from Share Premium Account
• In terms of this Scheme, no consideration was payable to the shareholders in respect of the shares which were to be cancelled. As a result, assessee’s shareholding of 288,13,17,286 equity shares in TTSL were reduced to half, i.e., 144,06,58,643.
• The said scheme was approved by the Hon’ble Delhi High Court vide judgment and order dated 07/11/2008.
• In the return of income for the A.Y. 2009-10 filed on 30/09/2009, assessee had shown long term capital loss on reduction on the shares of TTSL and claimed a loss of INR 2046,97,54,090.
• Assessing officer accepted the loss and passed the order accordingly.

PCIT View:

• Principal Commissioner of Income Tax (PCIT) in his revisionary jurisdiction issued a notice in 2015 to revise the assessment order on following grounds:
  • The loss of Rs 20,46,97,54,090/- on account of reduction of capital in computation only and not in the books of account.
  • If there is no consideration received or accruing to the assessee as a result of transfer, the machinery section enacted in section 48 would be wholly inapplicable and it would not be possible to compute profits or gains arising from the transfer of capital asset.
  • PCIT distinguished the decision of the Hon’ble Supreme Court in the case of Kartikeya Sarabhai reported that in that case, it was not a case of reduction in the face value of the shares but an effacement of the entire shares.
  • There can be no extinguishment of rights in the present case and the consideration received is Rs. Nil and not Rs. Zero.
  • Assessing Officer has failed to consider the decision of Mumbai ITAT Bench, in the case of Bennett Coleman and Co. Ltd. Vs. Addl.CIT 2011(9) TMI-ITAT, Mumbai, Special Branch where in it was ordered that if the earlier shares have been replaced or substituted by new shares then the same would not amount to transfer at all.

Accordingly, ld. PCIT directed the AO to determine the total income by disallowing the long-term capital loss of Rs. 2046.97 Crores.

ITAT View/Decision:

• There can be no dispute that there was a loss on the capital account by way of reduction of capital invested and therefore any loss on capital account, is a capital loss.
• Basis the various decisions quoted, if the right of the assessee in the capital asset stands extinguished either upon amalgamation or by reduction of shares it amounts to transfer of share within the meaning of 2(47) and therefore, computation of capital gains has to be made.
• In this case, there is no dispute about the cost, because assessee had incurred the cost for acquiring of the shares and therefore, there is no dispute regarding cost of acquisition.
• Hon’ble Gujarat High Court in the case of CIT vs. Jaykrishna Harivallabhdas had rejected the contention of the Revenue that the provision of capital gain should apply to actual receipts only cannot be accepted because it would result into incongruous and anomalous results because in case even where negligible or insignificant sum received, it would result in computation of capital gain or loss but in case where nothing was disbursed or received on extinguishment of rights will not result in loss cannot be upheld. The Hon’ble High Court even held that even where there is a „nil‟ receipt of the capital, the entire extinguishment of rights has to be written off as a loss resulting from computation of capital gains.
• The Hon’ble ITAT said rationale of the Hon‟ble Gujarat High Court is clearly applicable on the facts of the present case also because there could be no distinction where assessee receives some negligible or insignificant consideration and where assessee had received “Nil” consideration.
• Thus, ITAT agreed on that
  • In this case, the reduction of capital is the extinguishment of right on the shares, and it amounts to transfer within the meaning and scope of section 2(47)The loss on reduction of shares is a capital loss and not notional loss; and
  • Even when assessee has not received any consideration on reduction of capital, but its investment has reduced to loss resulting into capital loss and while computing the capital gain, the capital loss must be allowed or set-off against any other capital gain.
• Hon’ble ITAT distinguished the case of Bennett Coleman and Co. Ltd. Stating that it was a case of substitution of shares which is not the facts in the present case.
• A line of distinction needs to be drawn between cases in which the cost of acquisition or for that matter any other component of section 48 is incapable of ascertainment and cases in which it is ascertained as zero
• Thus, the Tribunal held that the AO has rightly allowed the long-term capital losses and its setting off.