[Opinion] Is Reduction of Share Capital with No Consideration to Shareholders Lead to Long-term Capital Loss?

CA V K Subramani – [2024] 160 taxmann.com 305 (Article)

The structure and concept of corporate entity provides the benefit of mobilizing huge resources from the public and putting them to intended use judiciously with accountability. In the process, both the persons seeking resources (after having contributed their share) and persons who contribute their resources by subscribing to the share capital, earn income in the form of dividend when holding the shares and on sale, either get appreciation in value or depreciation of the amount invested based on performance of the entity which is called in income-tax language as capital gain or loss. Given the lack of knowledge of the retail investors in particular the emerging scenario is that they ultimately lose their hard-earned money by stock market transactions with poor understanding of the movement of indices. There is not even a minimum lock in or holding period for shareholding and therefore retail investors in particular lose their money in bargain due to frequent purchase and sale. Given the attraction to foreign investors by the booming Indian share market indices it would not be possible in Indian context to think of introducing such lock in/minimum holding periods for share investments through legal framework since it is the buoyancy and optimism created all around might pooh-pooh even such thought process.

This refresher discusses whether share capital reduction by companies to set right their lopsided balance sheet would lead to capital loss in the hands of shareholders when they do not receive any consideration in return for the capital foregone by them. In this context, the decision in the case of Tata Sons Ltd v. CIT [2024] 158 taxmann.com 601 (Mum.-Trib) which has analysed the legal precedents, is the focus of this write up.

1. Tata Sons Ltd. case

The assessee in this case for the assessment year 2009-10 claimed long-term capital loss of Rs. 2046.98 crores. Factually, the assessee had 288.14 crore equity shares in Tata Tele Services Ltd (TTSL) acquired at various points of time. Since TTSL had incurred substantial losses in the course of its business, its paid-up share capital got eroded and it went in for a scheme of arrangement and restructuring. As per the scheme approved by the court, the paid-up equity share capital was reduced to 50%. The total share capital of the company which was originally 634.72 crore equity shares of Rs. 10 each got reduced to 317.36 crore equity shares.

The assessee’s shareholding correspondingly got reduced from 288.14 crore equity shares to its 50% being 144.07 crore equity shares. The scheme of share capital reduction led to wiping out the accumulated debit balance in profit and loss account and there was no payment of consideration to any of the shareholders in respect of the shares cancelled. It may be kept in mind that 50% of the shares held by the assessee got cancelled due to reduction of capital pursued under sections 100 and 391 of Companies Act, 1956. The facts relate to the assessment year 2009-10 before the introduction of Companies Act, 2013 and there is not much of change with regard to scheme of arrangement and restructuring by way of reduction of capital between the Companies Act, 1956 and Companies Act, 2013.

The reduction in capital of the company enabled it to adjust book losses of Rs. 1586.79 crores and adjust unabsorbed depreciation of the identical amount and the reduction in share capital enabled TTSL to make the balance sheet somewhat free from unnecessary flabs.

It may be noted that the assessee had capital gain from other shares during the same previous year relevant to the assessment year 2009-10 and claimed set off of the said long-term capital loss from capital reduction of TTSL against other long-term capital gains. During the course of assessment, the Assessing Officer (AO) raised the issue of set off of long-term capital loss of Rs. 2046.97 crores claimed by the assessee for which the assessee gave a detailed working of the long-term gains and losses. The AO posed certain questions and asked for explanation and finally accepted the assessee’s claim for set off of the said long-term capital loss against other long-term capital gains vide order passed under section 143(3).

The PCIT invoked revisionary jurisdiction under section 263 to revise the assessment order passed by the AO and gave a show cause notice to the assessee stating that the order of the AO was erroneous and prejudicial to the interests of the Revenue. He raised the following issues:

(a) The AO failed to take note of the fact that the loss on account of reduction of capital is only in computation and not in the books of account;

(b) The AO had failed to consider the fact that the assessee did not receive any consideration in the books of account to quantify the capital loss;

(c) The AO had failed to note that the loss suffered by the assessee is only a notional loss which should not have been set off against long-term capital gains on shares earned by the assessee;

(d) The AO has not considered the decision in the case of CIT v. Mohanbhai Pamabhai [1973] 91 ITR 393 (Guj.) where it was held that section 45 is a charging provision and would apply only if the consideration is received by the assessee or accrues to the assessee; (in this case there was no consideration received by the assessee); and

The AO failed to consider yet another decision in the case of Bennett Coleman & Co Ltd v. Addl. CIT [2011] 14 taxmann.com 1/133 ITD 1 (Mum.) which had considered the Supreme Court decision in the case of Kartikeya Sarabhai v. CIT [1997] 94 Taxman 164/228 ITR 163 (SC); CIT v. G.Narasimhan [1999] 102 Taxman 66/236 ITR 327 (SC) and CIT v. D.P. Sandhu Brothers Chembur (P) Ltd [2005] 142 Taxman 713/273 ITR 1 (SC) to conclude that if there is no consideration received or accruing to the assessee, the machinery provision contained in section 48 would be wholly inapplicable and it would not be possible to compute profits and gains from the transfer of capital asset.

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