KPMG Flash News 5 October 2011

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1 KPMG IN INDIA KPMG Flash News 5 October 2011 TAX Reduction of Equity share capital without variation of shareholder s rights and without payment of any consideration to the shareholder is not subject to capital gain provisions Recently, the Mumbai Special Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Bennett Coleman & Co. Ltd. 1 (the taxpayer) has held that provisions of capital gain do not apply to reduction of equity share capital by a company, where such reduction does not involve payment of any consideration to the shareholders or variation of any rights of the shareholders. It was held that reduction of proportionate shareholding of the shareholders pursuant to such capital reduction is only a notional loss. Since shareholders would not suffer any real loss of interest in the company, no capital loss would be allowable to the shareholder in such circumstance. Facts of the case The taxpayer had made investment in equity share capital of a group company, Times Guarantee Limited (TIL or the company) at a cost of INR million. Under Section 100 of the Companies Act, 1956, TIL reduced its equity share capital from INR million, divided into million shares of INR 10 each to INR million, divided into million shares of INR 5 each. Subsequent to such reduction, two equity shares of face value of INR 5 each were consolidated into one equity share of face value of INR 10. Consequently, equity share capital of the company was reconstituted as INR million divided into 8.99 million shares of INR 10 each. The reduction in equity share capital was adjusted against accumulated loss of the company. As such, the reduction did not involve any payment to the shareholders. By virtue of above reduction, taxpayer s investment in the company got reduced from INR million to INR million. By applying indexation, the taxpayer computed a long-term capital loss of INR 1 Bennett Coleman & Co. Ltd v. ACIT (ITA No. 3013/ Mum/ 2007, dated 30 September 2011) 1

2 million. The Assessing Officer rejected taxpayer s claim holding that no transfer had taken place, which was confirmed by the Commissioner of Income Tax (Appeals) in appeal by the taxpayer. Subsequently, matter came up for hearing before the Tribunal. Issue before the Tribunal Whether in light of above facts, the taxpayer can be deemed to have suffered a capital loss on reduction of share capital in a company? Taxpayer s contentions By virtue of capital reduction and subsequent consolidation, original shares held by the taxpayer were replaced with new shares. This should be treated as exchange of shares which is clearly covered by the definition of transfer within the meaning of Income-tax Act, 1961 (the Act). As the new shares were lesser than the original shares, the taxpayer had suffered a capital loss to the extent of reduction in shares. Additionally, extinguishment of a right in a capital asset amounts to transfer under Section 2(47) of the Act. Since reduction of share capital led to proportionate extinguishment of taxpayer s rights in the company, such extinguishment will amount to transfer under the Act. Reliance placed on Supreme Court judgments in Kartikeya v. Sarabhai 2, CIT v. G. Narsimhan (Decd.) & Ors. 3 and CIT v. Mrs. Grace Collis & Ors. 4 It has been held by various Courts that in the absence of ascertainable consideration, capital gain provisions would not be applicable. Although the taxpayer did not receive any consideration, it was not a case where consideration was not ascertainable. In the present case, it should be taken as zero. Accordingly, capital gain provisions were applicable and the taxpayer was entitled to capital loss as claimed. Tax department s contentions Investment in a share represents proportionate share of a shareholder in the assets of the company. Even after reduction of equity share capital, value of company s assets remained the same. Since proportionate share of the taxpayer in company s assets had not reduced, no loss was incurred by the taxpayer. Under Section 55(2)(v) of the Act, in the event of consolidation, division or conversion of original shares, cost of acquisition of such consolidated, divided or converted shares shall be same as that of the original shares. As such, even after capital reduction, cost of acquisition of shares held by the taxpayer would remain equal to 2 Kartikeya v. Sarabhai [1997] 228 ITR 163 (SC) 3 CIT v. G. Narsimhan (Decd.) & Ors [1999] 236 ITR 327 (SC) 4 CIT v. Mrs. Grace Collis & Ors [2001] 248 ITR 323 (SC) 2

3 cost of acquisition of original shares. In case the taxpayer is allowed capital loss on reduction and if such shares are sold in future, the taxpayer will claim cost of original shares as cost of acquisition which would amount to double benefit to the taxpayer. Whenever a company issues bonus shares, no capital gain is charged on mere allotment of such shares even though total shares held by a shareholder in the company are increased. Capital gain is charged only at the time of sale of such bonus shares. Applying the same principle, no capital loss should be allowed to the taxpayer on reduction of his shareholding in the company pursuant to capital reduction in the company. Tribunal s ruling The instant case involved substitution of one kind of shares held by the taxpayer with another kind of shares on capital reduction, because of its rights to the original shares. To that extent, it did not amount to relinquishment of a capital asset or extinguishment of any rights in the capital asset by the taxpayer. As held by the Supreme Court in CIT v. Rasiklal Maneklal (HUF) 5, in case of exchange one person transfers a property to another person in exchange of another property, such that the property continues to exist. In the present case, the original shares were substituted with another kind of shares and they ceased to exist. Accordingly, this would not amount to transfer. The case of CIT v. G. Narsimhan (Decd.) & Ors was distinguishable as in that case reduction of share capital was accompanied by certain assets being given to shareholders in the form of property, cash and adjustment of debit balances. Similarly, in Kartikeya v. Sarabhai, cash payout was made to preference shareholder on reduction in face value of preference share capital. Even in a case where transfer has taken place, capital gain provisions will not be applicable in absence of consideration. Unless consideration was present, computation mechanism of Section 48 of the Act will not be workable and therefore, such transfer could not be subject to tax. In the present case, nothing has been transferred by the company to the taxpayer and accordingly, it was a case of no consideration which cannot be substituted with zero consideration. Without any enabling provision in the Act, it is possible to argue that Section 45 of the Act will not be applicable in case of capital reduction not involving any apparent consideration. Reliance placed on B. C. Srinivasa Setty 6, Bombay Burmah Trading Corporation Ltd. 7 and Goodyear Tire and Rubber Co., USA, In Re. 8 5 CIT v. Rasiklal Maneklal (HUF) [1989] 177 ITR 198 (SC) 6 CIT v. B. C. Srinivasa Setty [1981] 128 ITR 294 (SC) 7 CIT v. Bombay Burmah Trading Corporation Ltd [1986] 161 ITR 386 (SC) 8 Goodyear Tire and Rubber Co., USA, In Re. [2011] 199 Taxman 121 (AAR) 3

4 Although extinguishment of rights in a capital asset amounts to transfer, taxpayer s rights have not been extinguished in the present case. Pursuant to capital reduction, shareholding of all the shareholders had been reduced such that proportionate shareholding of the taxpayer after capital reduction continued to be same as before such reduction. As there was no impact on assets of the company, net worth of the company and intrinsic value of shares held by the taxpayer also remained the same thereby not causing any loss to the taxpayer. Our comments This is an important judgment by the Tribunal as it elaborates on the governing principles for determination of capital gain implications in case of capital reduction. In arriving at its decision, the Tribunal has considered a number of precedents and applied their ratio to the present case. It has been pointed out by the Tribunal that in the absence of receipt of consideration by the shareholder and extinguishment of any rights arising out of the shareholding, reduction of share capital in a company will not attract capital gain tax provisions. As an analogy, it can be construed that capital reduction will involve capital gain implications only where it leads to variation of a shareholder s rights in the company and where such variation is compensated by payment of a quantifiable consideration. 4

5 Ahmedabad Safal Profitaire, B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar, Ahmedabad Tel: Fax: Bangalore Maruthi Infotech Centre, 11-12/1 Inner Ring Road Koramangala, Bangalore Phone: Fax: Chennai KPMG House No.10, Mahatma Gandhi Road, Nungambakkam High Road, Chennai Phone: Fax: Chandigarh SCO st Floor, Sector 8 C Madhya Marg Chandigarh Tel: Fax: Kochi 4/F, Palal Towers, M. G. Road, Ravipuram, Kochi Phone: +91 (484) Fax: +91 (484) Kolkata KPMG Infinity Benchmark Plot No. G-1, 10th floor Block - EP & GP, Sector V, Salt Lake City Kolkata Phone: Mumbai Lodha Excelus, Apollo mills compound, NM Joshi Marg, Mahalaxmi, Mumbai India Phone: Fax: Pune 703, 7th Floor Godrej Castlemaine, Next to Ruby Hall Clinic, Bund Garden Road, Pune Phone: /65 Fax: Delhi DLF Cyber City, Building no. 10, Block B, Phase II Gurgaon, Haryana Phone: Fax: Hyderabad KPMG, /2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad Phone: The information contained herein is of a general nature and is not intended to address the circumstances of 2011 KPMG, an Indian Partnership and a member firm any particular individual or entity. Although we endeavour to provide accurate and timely information, there of the KPMG network of independent member firms can be no guarantee 2011 that KPMG, such information an Indian Partnership is accurate as and of the a member date it is firm received of the or that KPMG it will network continue of to independent affiliated member with KPMG firms International affiliated with Cooperative ( KPMG be accurate in KPMG the future. International No one should Cooperative act on such ( KPMG information International ), without appropriate a Swiss professional entity. All rights advice reserved. International ), a Swiss entity. All rights reserved. after a thorough examination of the particular situation. 1

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