Introduction
ABC (Company) consider to reduce the equity share capital of the promoters of the company pursuant to which, the company will distribute land to the promoters by entering into a scheme of capital reduction sanctioned by High Court in accordance with section 100 of Companies Act, 1956.
Income Tax Implications
Relevant provisions and Case Laws
According to Section 2(22)(d) of Income Tax Act, 1961 (“Act”), dividend includes any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits whether such accumulated profits have been capitalised or not.
The taxability of capital reduction is not expressly mentioned in Act. However in accordance with landmark judgement decided by Supreme Court in CIT (Madras) vs. G. Narasimhan (Died) By Heirs Kantha, Narasimhan ^Ors wherein the Hon’ble Supreme Court held that the amount distributed by a company on reduction of share capital has two components:-
- distribution attributable to accumulated profits; and
- distribution attributable to capital (except capitalised profits)
The reduction of share capital amounts to ’transfer’ in the hands of shareholders .The Supreme Court held that out of the amount received on reduction of share capital, the amount attributable to accumulated profits will be deemed as dividend u/s 2(22)(d) and the balance amount is the sale proceeds of the shares so reduced.
It is only when any distribution is made which is over and above the accumulated profits of the company (capitalised or otherwise), that the question of a capital receipt in the hands of a shareholder arises.
The original cost to that shareholder of acquisition of that right in the share which stands extinguished as a result of reduction in the share capital will have to be deducted from the capital receipt so determined.
Conclusion
Therefore, in the present case, to the extent of the accumulated profits in the hands of Company, whether such accumulated profits are capitalised or not, the return to the shareholder on the reduction of share capital, is a return of such accumulated profits. This part would be taxable as Dividend in the hands of company which is taxable @ 16.995% (net).
The balance may be subject to tax as capital gains in the hands of shareholder, if they accrue.
In view of the above facts of the judgement r/w provisions, the present case involves following taxability:-
Step 1: Deemed Dividend u/s 2(22)(d) of Act in hands of Company on distribution of land
The amount of distribution of assets to the promoters, to the extent the company possess accumulated profits whether capitalised or not, will be taxable in the hands of company, wherein the company is required to pay CDT @ 16.995% (net).
Step 2: Capital Gains in hands of promoters of Company on capital reduction and receipt of land from the company
Pursuant to capital reduction, the Fair Market Value of the Asset or any other money received by promoters, as reduced by deemed dividend u/s 2(22)(d) on which the company has paid CDT, shall be treated as sale consideration in lieu of extinguishment of share capital of promoters.
However the Cost of Acquisition of the asset shall be the cost to the promoters in accordance with section 48 of Act. Thus Capital Gains shall be levied @ 20% u/s 112 of Act.
Step 3: Capital Gains in hands of promoters of Company on sale of land
Capital gain @ 20% shall be chargeable in hands of promoters on sale of land. The period of holding shall be considered from the date of receipt of assets pursuant to capital reduction.
Companies Act Implications [Section 100-105 of Co Act, 1956]
i. Ensure that Articles of Association (AOA) of Company authorises the reduction of share capital. If not, then AOA may be altered by passing Special Resolution (SR) at General Meeting (GM), which shall have to be filed along with the Explanatory Statement u/s 102 of Co. Act 2013 and altered AOA, in Form MGT – 14 within 30 days of passing thereof. [Voting not required to be carried out through Postal Ballot]
ii. It may alter its Memorandum by reducing the amount of its share capital and of its shares accordingly.
iii. To convene and hold a Board Meeting approving the Scheme of Capital Reduction, and fixing a date for the holding of GM for passing SR to approve the Scheme.
iv. To intimate to the Bombay Stock Exchange (“BSE”), the proposed alteration to capital within 15 minutes of closure of Board Meeting. [Clause 22(c) of Listing Agreement with BSE]
v. To issue notices to all the members of the company, and send at-least 21 days’ prior notice to the BSE before making any alteration to the listed securities. [Clause 28 of Listing Agreement with BSE]
vi. A special resolution is to be passed by company in GM for reduction of capital by distribution of the accumulated profits amongst the shareholders. [Voting not required to be carried out through Postal Ballot].
vii. A copy of the Scheme to be forwarded to the BSE at-least 1 month before it is filed with the Court. [Clause 24(f) of Listing Agreement with BSE]
viii. File SR along with Explanatory Statement u/s 102, and Altered MOA & AOA with the ROC in Form MGT-14 within 30 days of passing thereof. [ Sec. 117(1) and (3) of Co. Act 2013 r/w Rule 24 of Companies (Management and Administration) Rules, 2014]
ix. Company shall then have to file a petition with the Court for an order confirming the reduction of capital.
x. A certified copy of the order and of the minutes of the meeting approved by the court, showing the number of shares, amount of each share and the paid up amount of share capital, shall have to be obtained by company from the court, and be registered with the ROC.
xi. ROC will then issue a certificate confirming the reduction of capital.
xii. Issue notices to the shareholders inviting applications for refund of the share capital.
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