Loss on pro-rata reduction of share capital is “Notional”. In absence of consideration, capital gains provisions do not apply
The assessee invested Rs.24.84 crores in equity shares of Times Guarantee Ltd. Pursuant to a scheme of reduction u/s 100 of the Companies Act, the face value of Times Guarantee shares was first reduced to Rs. 5 from Rs. 10 and thereafter two equity shares of Rs.5 each were consolidated into one equity share of Rs.10. The result was that the assessee’s investment was reduced to Rs.12.42 crores. The assessee, relying on Kartikeya Sarabhai 228 ITR 163 (SC) & G. Narsimhan 236 ITR 327 (SC), claimed that the reduction in face value was a “transfer” and that it had suffered a long-term capital loss of Rs.22.21 crores after indexation. The AO disallowed the claim on the ground that (i) there was no “transfer” and (ii) there was no “consideration” and the machinery provisions of s. 48 cannot apply. The issue was referred to the Special Bench. HELD by the majority (R. S. Syal, AM, dissenting):
(i) First the face value of each share was reduced from Rs. 10 to Rs. 5 and then two shares of Rs. 5 each were consolidated into one share of Rs. 10 each. If the argument is that earlier shares were replaced or substituted by new shares, then there is no “transfer” but it is merely a case of substitution of one kind of share with another kind of share (Rasiklal Maneklal (HUF) 177 ITR 198 (SC) followed);
(ii) Assuming that a reduction of shares in the manner done by the assessee amounts to a “transfer”, s. 45 is not attracted because there is no “consideration” received by the assessee for the transfer. Unless and until a particular transaction leads to “computation” of capital gains or loss as contemplated by s. 45 & 48, it cannot attract capital gain tax. On facts, the assessee had not received any consideration for reduction of share capital. While the number of shares held by the assessee has reduced to 50%, nothing had moved from the side of the company to the assessee (B. C. Srinivasa Setty 128 ITR 294 (SC) & Bombay Burmah 147 TR 570 followed)
(iii) Further, by the reduction, the assessee’s rights had not been extinguished because it continued to hold the same percentage in the holding of Times Guarentee as it did before the reduction. There was no change in the intrinsic value of his shares and even his rights vis-à-vis other shareholders as well as vis-à-vis company remained the same. The concept of capital gains has to be understood as in the commercial world and there was no loss that can be said to have actually accrued to the shareholder as a result of reduction in the share capital. Also, there would be no change even in the cost of acquisition of shares by virtue of s. 55(v).
Per R. S. Syal, AM, dissenting:
(iv) On the point of “transfer”, a reduction of share capital u/s 100 of the Companies Act can take place either by paying excess capital to the shareholders or by cancelling lost capital. While the first method amounts to a “transfer” as held in Anarkali Sarabhai 224 ITR 422 (SC), the other method (adopted by the assessee) results in an “extinguishment of rights” in the shares which is also a “transfer” as held in Grace Collis 2481TR 323 (SC). Consequently, a reduction of capital by cancellation of shares results in a “transfer”;
(v) On the point that a capital loss cannot be computed if there is no consideration, while it is true that the failure of the computation provisions results in a failure of the charging provisions as held in B. C. Srinivasa Setty, there is a distinction between a case where the computation provision is incapable of ascertainment and a case where it is ascertained as zero or Nil. In the present case, the consideration received by the assessee was Nil. It was not a case where the consideration was incapable of ascertainment (observations in Mohanbhai Pamabhai 91 ITR 393 (Guj) treated as obiter dicta. Bombay Burma Trading Corp 147 Taxation 570 (Bom) not followed as being only a case of rejection of a s. 256(2) application);
(vi) On the point that there is no “loss”, the argument that as with the reduction of capital, there is a corresponding increase in the net worth per share and the assessee’s interest in TGL remains unaffected on an overall basis is not acceptable because after the reduction, the assessee is left with lesser number of shares. The fact that the book value has increased has no effect. An increase or decrease in the market value of shares is of no consequence if the shares are held as investment (principles laid down in Dalmia Investment Co & Dhun Dadabhoy Kapadia 63 ITR 651 (SC) held not applicable on the ground that Dalmia was in the context of shares held as stock-in-trade and both were under the 1922 Act);
(vii) the apprehension that the assessee would derive a double advantage by claiming the loss now and the entire cost at the time of sale is unfounded because (a) the assessee’s books shows the investments at the reduced amount and (b) u/s 55(2)(iv)(v), the cost of acquisition of the remaining consolidated shares will be the reduced amount.