reduction share

Reduction of Share Capital – An Overview

1. INTRODUCTION

The need of reducing capital may arise in various circumstances, for example, accumulated business losses, assets of reduced or doubtful value, etc. As a result, the original capital may either have become lost or a company may find that it has more resources that it can profitably employ. In either of these cases, the need may arise to adjust the relation between capital and assets.

2. WHAT IS REDUCTION OF CAPITAL?

Reduction of Capital means reduction of issued, subscribed and paid-up capital of the company. Reduction of share capital may be effected in the following ways:

1. In respect of share capital not paid-up, extinguishing or reducing the liability on any of its shares. (For example, if the shares are of ` 100 each of which ` 75 has been paid, the company may reduce them to ` 75 fully paid-up shares and thus relieve the shareholders from liability on the uncalled capital of `25 per share)

2. Cancel any paid-up share capital, which is lost, or is not represented by available assets. This may be done either with or without extinguishing or reducing liability on any of its Shares (For example, a share of ` 100 each fully paid-up is represented by ` 75 worth of assets. In such a case reduction of share capital may be effected by writing off
` 25 per share. The assets side of balance sheet may include useless assets which are cancelled and on the liability side share capital is reduced) or

3. Pay off the paid-up share capital, which is in excess of the needs of the company. This may be achieved either with or without extinguishing or reducing liability on any of its shares. (For example, where the shares are ` 100 each fully paid, reduce them to ` 75 each and pay back `25 per share.)

All the above including repayment of capital requires prior sanction of court. In other words, there can be no retrospective approval for reduction of share capital.

3. IMPLICATIONS UNDER COMPANIES ACT

3.1 Power of the company for reduction of share capital

For a company to reduce its share capital, it should have the power under its Articles of Association to do so. An authority to do so given by the Memorandum of Association is of no avail. If the articles do not contain any provision for reduction of capital, the articles must first be altered so as to give such power and then the special resolution for reducing capital must be passed. The reduction effected by such resolution must be confirmed by the Tribunal. (Till the time Tribunals are formed the power remains with the appropriate High Court) [Section 100]

3.2 Modes of reduction of share capital

The Act does not prescribe the manner in which the reduction of capital is to be effected nor is there any limitation of the power of the court to confirm the reduction except that it must be first be satisfied that all creditors entitled to object to the reduction have either consented to the said reduction or that they should be paid off or their interest secured.

(British and American Trustee and Finance Corp. vs. Couper (1894) AC 399)

Reduction of capital in the following ways is permissible under the Act:

1. Diminishing the nominal amount of the share so as to leave a less sum unpaid;

2. Diminishing the nominal amount of any shares by writing off or repaying paid-up capital;

3. Diminishing the nominal amount by combining both (1) and (2);

4. Diminishing the number of shares by extinguishing the existing liability on certain shares, writing off or repaying the whole amount paid-up thereon, and cancelling them.

Equal Reduction of Shares of One Class

Where there is only one class of shares, prima facie, the same percentage should be paid off or cancelled or reduced in respect of each share, but where different amounts are paid up on shares of the same class, the reduction can be effected by equalising the amount so paid-up.

(Marwari Stores Ltd. vs. Gouri Shanker Goenka (1936) 6 Comp. Cas 285)

4. PROCEDURAL ASPECTS AS PER COMPANIES ACT

4.1Special Resolution

This is the first and main requirement for the reduction of share capital. Unless a special resolution, as authorised by the articles, is passed for reduction of the share capital, a company cannot effect share reduction.

However, in the following cases there is no need for passing the aforesaid resolution,

1. Where redeemable preference shares are redeemed in accordance with the provisions of sections 80 and 81.

2. Where any shares are forfeited for non-payment of calls, though the forfeiture as a fact amounts to a reduction of capital.

3. Where there is a surrender of shares to a company whether by way of settlement of dispute or for any other reason.

4. Where the nominal share capital of a company is reduced by cancelling any shares, which have not been taken or agreed to be taken by any person.

5. Where company purchases its own shares in pursuance of the provisions in section 77A of the Companies Act, 1956.

4.2 Tribunal Sanction

Next step for the Reduction of Share Capital is to secure the sanction of the Tribunal for reduction. Before confirming the reduction the Tribunal shall be satisfied that the

• consent of the creditors to the reduction has been obtained or

• creditors have been discharged or

• their debts or claims have been discharged or settled or secured.

(The ‘creditor’ for this purpose means a person who has a debt or any claim against the company of such a nature as would have been provable in winding up.)

• As per section 102, the Tribunal has first to be satisfied that the creditors who had objected to the reduction that either their consent to the reduction has been obtained or their debts or claims have been discharged or settled or secured.

• If the company does not admit or provide the full amount of debt or the amount is contingent or not ascertainable then the Tribunal has the right to fix the amount.

• Under the special circumstances and if the Tribunal thinks it proper then it has the power to dispense with the provisions of securing the debts of the creditors as mentioned above.

• In other cases the creditors can object only with the consent of the Tribunal.

4.3 Tribunal confirming reduction and power on making such order

The Tribunal may direct the company that the words "and reduced" be added to the Company’s name for a specified period, and that the Company must publish the reasons for reduction of share capital and also the causes which led to it, with a view to giving proper information to the public.

4.4Registration & Minute of Reduction

• As per section 103(4) minutes with a copy of the order has to be registered with the Registrar of the Companies and according to that Registrar of Companies will issue Certificate under his hand or authenticated by his seal.

• Once the minutes get registered it shall be deemed to be substituted for the corresponding part of the memorandum of the company, and shall be valid and alterable as if had been originally contained therein. The substitution of any such minute as aforesaid for part of the memorandum of the company shall be deemed to be an alteration of the memorandum within the meaning and for the purpose of section 40.

4.5 Liability of Members and Penalty

• On the reduction of share capital, the extent of liability of any past or present member on any call or contribution shall not exceed the difference between the amount paid on the share, or the reduced amount, if any, which is to be deemed to have been paid thereon, by the member, and the amount of the shares fixed by the scheme of reduction.

• If, however any creditor entitled to object to the reduction of share capital is not entered in the list of creditors by reason of his ignorance of the proceedings for reduction and after the reduction, the company is unable to pay his debt or claim then every person who was member at the time of the registration of the order and minutes of the reduction will be liable to contribute for the payment of the debt of the creditor.

• If any officer of the company, who conceals the name of the creditor or misrepresents the nature of the debt or claim of the creditor who is entitled to object to the reduction of the share capital as per the provisions of section 105.

5. REDUCTION OF CAPITAL UNDER SECTIONS 397 AND 402

Apart from reduction of capital under section 100 there is another circumstance, when share capital can be reduced. In the case of oppression and mismanagement the Tribunal has general powers under sections 397 and 398 and specific power also under section 402. Under this the Tribunal can pass an order for

• Purchase of shares of any members of the company and

• Consequently there is reduction of the share capital.

Cosmo Steel P Ltd. vs. Jairam Das Gupta & Others (1978) 48 com cas 312 SC

This was an application of section 397. Hon’ble court has passed the order under section 402 directing the company to purchase the share of the members and the consequently reduced the share capital.

It was argued that reduction of share capital is required a Special Resolution. The Supreme Court has commented as follows:

Capital can be reduced under two circumstances,

• Where a company reduces a capital u/ss. 100 to 104, a Special Resolution and confirmation by the Tribunal is required.

• When the Tribunal passes an order u/s 402, the question of Special Resolution does not arise. Otherwise the Tribunal will be at mercy of the share holders.

6. IMPLICATIONS UNDER INCOME-TAX ACT, 1961 (‘IT Act’)

When any company reduces the share capital as per the provisions of the Companies Act, 1956 by way of reducing the face value of shares or by way of paying off part of the share capital, it amounts to extinguishments of the rights of the member to the extent of reduction of face value of share capital and therefore it is treated as transfer under sec. 2(47) of the IT Act. The amount received is liable to capital gain tax u/s. 45 of the IT Act.

There are two aspects involved in the taxability of the income received on reduction of capital in the hands of the share holders of the company

• Amounts distributed by the company on reduction of share capital to the share holders attributable to accumulated profits will be considered as deemed dividend u/s. 2(22)(d) and will be chargeable accordingly, and,

• Distribution attributable to capital will be subject to capital gains tax u/s. 45.

Only the distribution, which is over and above the accumulated profits, can be treated as capital receipts in the hands of share holder and only when the capital receipt is in excess of original cost of acquisition of that interest which stands extinguished, capital gains will arise to the share holder.

This is supported by the following case laws:

• Kartikeya V. Sarabhai vs. CIT 228 ITR 163 (SC),

It is held in this case that even if there is reduction in the face value of the shares and consequent payment by the company to the share holder towards such reduction, the transaction results in extinguishments of right in the shares held by the shareholder. Consequently, the reduction of the share capital would be eligible to capital gains. The Supreme Court has referred the decision in the matter of Anarkali Sarabhai vs. CIT (SC), 224 ITR 422 in which case preference shares were redeemed in entirety whereas in the present case it was partly redeemed by reduction of share capital, therefore the analogy is same.