Loss on Reduction of share capital is allowable

IN THE INCOME TAX APPELLATE TRIBUNAL

MUMBAI SPECIAL BENCH ‘B’ MUMBAI

Date of Hearing: 16-08-2011 Date of Pronouncement: 30-09-2011

Question to be decided:

This Special Bench has been constituted by the Hon'ble President to consider the following question:

“Whether on the facts and in the circumstances of the case, the CIT(A) was justified in disallowing  long term capital loss of Rs.22,21,85,693/- on account of reduction in paid up equity share capital? “

Facts of the case –

During the course of assessment proceedings, the Assessing Officer noticed that assessee had claimed long term capital loss amounting to Rs.22,21,85,693/-. It is not in dispute that assessee made an investment of Rs.2484.02 lacs in equity shares of a group company viz., Times Guarantee

Limited [for short TGL]. Under sec.100 of the Companies Act, 1956 TGL applied for reduction of equity share capital and approached the Hon'ble Bombay High Court for approval of the same. The Hon'ble High Court approved the petition of TGL and allowed reduction in its share capital by 50% by reducing the face value of each equity share from Rs.10/- to Rs.5/- . Consequently, assessee’s investment in TGL got reduced from Rs.2484.02 lacs to Rs.1242.01 lacs. After applying the indexation a sum of Rs.22,21,85,693/-was claimed as long term capital loss.

Contention of the Assessing Officer –

Argument No.1: The Assessing Officer, after considering these submissions, was of the opinion that in the case of Kartikeya V. Sarabhai [supra] the court was concerned with the reduction of non-cumulative preference shares. Therefore, according to the Assessing Officer, this was merely a case involving reduction in face value of preference shares and accordingly same should not be applied particularly because the voting rights were also reduced proportionately on the resolution which effected the rights of preference shareholders whereas, in case of equity shares, there is no reduction in the rights of such equity shareholders

Argument No. 2: He further observed that in the present case assessee has not received any consideration for reduction in the value of shares, nor any part of the shares have been passed to anyone else. This means, that there was no change in the rights of the assessee vis-à-vis other shareholders and, therefore, no transfer had taken place and, thus, assessee was not entitled to the claim of long term capital loss.

Argument No. 3:

The revenue contended that the reduction in face value of shares is not a ‘transfer’ on account of the following:

1. The assessee’s percentage of shareholding, immediately before reduction of share capital and immediately after the reduction, remained the same (i.e. 74.9 percent).

2. As distribution of surplus profit to shareholders as bonus is not taxable, in the same way, losses of the company which have been adjusted by reducing the capital cannot be allowed.

Appeal to CIT (Appeals) against the order of Assessing officer:

Ld. CIT (A) who upheld the action of the Assessing Officer on similar reasoning.

Contention of the assessee-

In view of the decision of the Hon'ble Supreme Court in the case of Kartikeya V. Sarabhai [228 ITR 163]- wherein it was held that reduction in face value of preference shares would amount to transfer such loss was allowable.

In terms of sec.100 of the Companies Act, 1956 which has been approved by the Hon'ble High Court. The company was accordingly allotted 67,37,399 new shares in place of old shares at 1,34,74,799.

He pointed out that even ISIN No. has changed from INE 289C01025 to INE 289C01017, which basically means that new shares are different shares because different ISIN INE No. has been allotted. On a query by the Bench he filed a copy of the clarification issued by the SEBI and pointed out at para-29 wherein it has been clarified as under:

“ISIN [International Securities Identification Number] is a unique identification number allotted for a security [E.g –INE 383C01018]. Equity fully paid-up, equity partly paid up, equity with differential voting/dividend rights issued by the same issuer will have different ISIN.”

The assessee contended that the expression ‘transfer’ as defined in section 2(47) of the Act is an inclusive definition and, inter alia, provides that relinquishment of an asset or extinguishment of any right therein, would also amount to transfer of a capital asset. Thus, even extinguishment of right in a capital asset would amount to transfer and in the instant case as assessee’s right got extinguished proportionately, to the reduction of capital, it would amount to transfer. The assessee further contended that to invoke the provisions of section 45 read with section 2(47) of the Act, sale of a capital asset is not a necessary condition.

Thus, Learned counsel contended that old shares have been replaced with new shares which is a reduced number and this should be treated as exchange of shares which is clearly covered by the definition of ‘transfer’ and once the shares have been transferred it is a basic condition for attracting sec.45, then the loss incurred on the same should be treated as capital loss.

The assessee argued that since, in the present case, there is zero consideration, it can be construed that the consideration was ascertainable, and therefore, same should be taken as zero and capital loss should be allowed.

Tribunal Ruling:

The contention of the ld. Deptt’s Representative (D.R.), in simple words, is that though there is a transfer on reduction of capital, but no loss can result due to simultaneous equal increase in the book value of the remaining shares.

View of Tribunal-If increase in the book value of the remaining shares is considered as a relevant factor to deny  the loss on transfer due to reduction of capital, then every increase or decrease in the book value of the shares should also be considered as resulting into income or loss under the head `Capital gains’

Here is a case in which the share-holding of the assessee has come down by fifty per cent. If it had earlier 100 shares at its disposal for sale at any time, now it is left with only 50 shares. Its right over the 50 shares, which have been cancelled by the company, has come to ‘a nothing’ and it has resulted into transfer.  Now after the reduction, it cannot go to market to sell 100 shares but has only 50 shares at its disposal. The transaction of reduction into capital has come to an end, making the assessee poorer by 50 shares without any corresponding inflow of consideration.

It would be altogether different transaction when remaining shares become subject matter of transfer. At that point of time the question of capital gain would arise by considering the market price of such shares vis-à-vis the cost of acquisition of the remaining shares. If the market price further goes up at the time of transfer of the remaining shares, there will result still higher income. But if   unfortunately, say TGL’s future has more adverse time and that the market price of its shares further goes down, the assessee will stand to lose at the time of the transfer of the remaining shares as well.

In that case, the fact “that on reduction of capital there was some increase in the book value of the remaining shares” will not come to mitigate the loss to the assessee subsequently at the time of second transaction of transferring remaining shares.

It is thus clear  that the increased or reduced or static book value of the shares of a company has no relation either with its market price or computation of capital gain, either at the time of transfer on reduction of capital or when the remaining shares in possession are transferred. This contention raised on behalf of the Revenue is thus not tenable.

Final Judgment

Once a capital asset is transferred, the natural consequence which follows is that there is either gain or loss unless full value of consideration equals the cost of acquisition. As the reduction of capital has been held to result into `transfer’, the excess of cost of acquisition of such shares over the full value of consideration will lead to loss.

IS ASSESSEE DERIVING DOUBLE ADVANTAGE?

It is natural that when on the transfer of such shares, the proportionate cost has been taken into consideration for computing capital gain on their transfer , that cost shall cease to be available with the assessee for the remaining shares.

I, therefore, hold that the assessee cannot derive double advantage by firstly claiming deduction of Rs.12.42 crores at the stage of reduction of share capital and again assuming the cost of acquisition of the remaining shares at the full value of Rs.24.84 crores. The cost of acquisition of the remaining consolidated shares in TGL shall stand reduced u/s55(2)(b)(v) to Rs.12.42 crores.

Note: The judgment has attained finality because the Revenue did not appeal against the order of ITAT before the high court.

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Saurabh Maheshwari

E-mail- saurabhchokhra92@gmail.com