suggest treatment of shares to avoid tax liability
This query is : Resolved
Querist : Anonymous
Querist :
Anonymous
(Querist)
05 June 2010
1. The Private Company was incorporated in beginning 2007
2. The Paid up Capital of Rs.1 lac (10000 shares of Rs.10/- each) was divided as follows:
1. Mr.P 99.90%
2. Mr.Q .1%
3. Mr.P, Q, R and S were the directors of the Company. Mr.P had entered into a shareholder agreement (SHA) with R and separate agreement with S to form this new Company, whereby Mr.P was to transfer 10% of shares each to R and S respectively. The same was done in year 2008 at face value. The SHA however, does not form part of the articles and is being informally agreed between the parties.
Revised Shareholding pattern in 2008 (Post above transfer) is as follows:
1. Mr.P 79.90%
2. Mr.Q .1%
3. Mr.R 10%
4. Mr.S 10%
4. Now, there was a deadlock in management as Mr.S could not bring in desired business and there was non-performance. Mr.S has resigned in end 2009 at his will and has also returned the shares at nil consideration and wants to move on. The same has been mutually agreed to between Mr.P, Mr.R and Mr.S.
5. The Book Value of the Company is very high in view of accumulated profits. Mr.R wants to just return the shares without any consideration and move on.
6. The Company has further done private placement in March 2010 for 40,000 shares to a Company which subsequent to this becomes its holding Company (80%). The Total Paid up Capital now is Rs. 5 lac.
Query :
1. Company Law : How can he return the shares to the Company so that it does not hit section 77 (Purchase of own shares by a company) and Section 100 (Reduction of Capital) of the Companies Act, 1956.
2. Tax : Please enlighten on the tax implications u/s 56 or any other section. We do not want any tax implication in the hands of the recipient.
2. The Paid up Capital of Rs.1 lac (10000 shares of Rs.10/- each) was divided as follows:
1. Mr.P 99.90%
2. Mr.Q .1%
3. Mr.P, Q, R and S were the directors of the Company. Mr.P had entered into a shareholder agreement (SHA) with R and separate agreement with S to form this new Company, whereby Mr.P was to transfer 10% of shares each to R and S respectively. The same was done in year 2008 at face value. The SHA however, does not form part of the articles and is being informally agreed between the parties.
Revised Shareholding pattern in 2008 (Post above transfer) is as follows:
1. Mr.P 79.90%
2. Mr.Q .1%
3. Mr.R 10%
4. Mr.S 10%
4. Now, there was a deadlock in management as Mr.S could not bring in desired business and there was non-performance. Mr.S has resigned in end 2009 at his will and has also returned the shares at nil consideration and wants to move on. The same has been mutually agreed to between Mr.P, Mr.R and Mr.S.
5. The Book Value of the Company is very high in view of accumulated profits. Mr.R wants to just return the shares without any consideration and move on.
6. The Company has further done private placement in March 2010 for 40,000 shares to a Company which subsequent to this becomes its holding Company (80%). The Total Paid up Capital now is Rs. 5 lac.
Query :
1. Company Law : How can he return the shares to the Company so that it does not hit section 77 (Purchase of own shares by a company) and Section 100 (Reduction of Capital) of the Companies Act, 1956.
2. Tax : Please enlighten on the tax implications u/s 56 or any other section. We do not want any tax implication in the hands of the recipient.
Querist : Anonymous
Querist :
Anonymous
(Querist)
14 June 2010
Awaiting reply... Please advise..
Thanks
Thanks
26 July 2025
This is a nuanced situation involving **Company Law** and **Income Tax** aspects of share transfers, especially shares returned at nil consideration or “buy-back” situations. Here's a detailed breakdown and suggestions:
---
## 1. Company Law Treatment
### Key Concerns:
* **Section 77 of Companies Act, 1956** (now replaced by Companies Act, 2013 provisions) prohibits a company from purchasing its own shares except under certain conditions (buy-back).
* **Section 100** deals with **reduction of share capital** by a company, which requires **court approval** and compliance with procedural safeguards.
### How can Mr.S or Mr.R return shares without violating these sections?
#### Options:
**A) Buy-back of Shares:**
* The company can buy back shares from Mr.S or Mr.R under **Section 68 of Companies Act, 2013** (replacing 1956 Act).
* Conditions:
* Buy-back is allowed out of free reserves or securities premium.
* Maximum buy-back limit not exceeding 25% of paid-up capital and free reserves.
* Compliances include passing a board resolution, special resolution, and filing with ROC.
* Buy-back at **fair value** is required.
* Buy-back at nil consideration is **not legally allowed**.
**B) Capital Reduction:**
* Company may reduce share capital to cancel shares surrendered by Mr.S or Mr.R.
* Requires:
* Approval from shareholders via special resolution.
* Approval from the court.
* Compliance with procedure in Section 100.
* This is time-consuming and expensive.
**C) Transfer of Shares Back to Mr.P or Other Shareholders:**
* Mr.S or Mr.R can **transfer shares back to Mr.P** or other shareholders at fair value or nominal value.
* No involvement of company purchasing shares, hence **Section 77 or 100 does not apply**.
* Share transfer must be registered and comply with Companies Act.
**D) Forfeiture of Shares:**
* If shares were partly paid and unpaid, company can forfeit shares for non-payment.
* Not applicable here as shares are fully paid.
---
## 2. Tax Implications (Section 56 & Others)
### Situation:
* Mr.S and Mr.R want to “return” shares at **nil or zero consideration**.
* Company has high book value; shares have high fair market value (FMV).
### Section 56(2)(vii) - Tax on Receipt of Shares Without Consideration:
* If a person receives shares **without consideration** or for inadequate consideration, the **difference between FMV and consideration received** is taxed as **Income from Other Sources** in the hands of recipient.
* So if Mr.P (or any shareholder) receives shares as a gift or nil consideration, this difference may be taxable.
### For Mr.S and Mr.R (Transferors):
* Transferring shares at nil consideration leads to **capital loss**.
* Capital loss can be set off against capital gains subject to provisions of Income Tax Act.
### For Company:
* If company buys back shares at FMV, company pays consideration and there is no income tax implication.
* If shares are forfeited or cancelled, no direct tax implication to company except on capital gains if any.
---
## 3. Recommendations to Avoid Undue Tax Burden
| Issue | Suggested Approach | Reasoning |
| ---------------------------------------------- | --------------------------------------------------- | ------------------------------------- |
| Returning shares to Company | Use **buy-back** procedure at FMV | Legal and tax compliant |
| Returning shares at nil consideration | Transfer shares to other shareholders (Mr.P) at FMV | Avoid Section 56(2)(vii) implications |
| Shareholder resigning and giving up shares | Sell shares at FMV to avoid gift implications | Proper valuation is key |
| Company issuing new shares (private placement) | Comply with valuation and pricing regulations | Avoid tax and regulatory issues |
---
## 4. Summary
| Party | Action | Tax & Legal Impact |
| ----------------------------------- | ------------------------------------------------ | -------------------------------------------------------------- |
| Mr.S / Mr.R | Sell shares at FMV to Mr.P or company (buy-back) | Capital gains tax for transferor; no income tax for transferee |
| Company | Buy-back at FMV | Compliant with law, no tax liability |
| Mr.P | Receives shares at FMV | No income tax liability |
| Share transfer at nil consideration | Taxable under Section 56(2)(vii) | To be avoided |
---
## 5. Additional Notes
* **Proper valuation by a registered valuer is essential** to determine FMV.
* All transactions should be **documented and recorded properly**.
* **Consult company secretary / legal advisor** to comply with procedural aspects of buy-back and share transfer.
* For tax, maintain **proof of consideration, valuation reports, agreements**.
---
If you want, I can help draft a **step-by-step plan for buy-back or share transfer** compliant with Companies Act and Income Tax laws. Would that be helpful?
---
## 1. Company Law Treatment
### Key Concerns:
* **Section 77 of Companies Act, 1956** (now replaced by Companies Act, 2013 provisions) prohibits a company from purchasing its own shares except under certain conditions (buy-back).
* **Section 100** deals with **reduction of share capital** by a company, which requires **court approval** and compliance with procedural safeguards.
### How can Mr.S or Mr.R return shares without violating these sections?
#### Options:
**A) Buy-back of Shares:**
* The company can buy back shares from Mr.S or Mr.R under **Section 68 of Companies Act, 2013** (replacing 1956 Act).
* Conditions:
* Buy-back is allowed out of free reserves or securities premium.
* Maximum buy-back limit not exceeding 25% of paid-up capital and free reserves.
* Compliances include passing a board resolution, special resolution, and filing with ROC.
* Buy-back at **fair value** is required.
* Buy-back at nil consideration is **not legally allowed**.
**B) Capital Reduction:**
* Company may reduce share capital to cancel shares surrendered by Mr.S or Mr.R.
* Requires:
* Approval from shareholders via special resolution.
* Approval from the court.
* Compliance with procedure in Section 100.
* This is time-consuming and expensive.
**C) Transfer of Shares Back to Mr.P or Other Shareholders:**
* Mr.S or Mr.R can **transfer shares back to Mr.P** or other shareholders at fair value or nominal value.
* No involvement of company purchasing shares, hence **Section 77 or 100 does not apply**.
* Share transfer must be registered and comply with Companies Act.
**D) Forfeiture of Shares:**
* If shares were partly paid and unpaid, company can forfeit shares for non-payment.
* Not applicable here as shares are fully paid.
---
## 2. Tax Implications (Section 56 & Others)
### Situation:
* Mr.S and Mr.R want to “return” shares at **nil or zero consideration**.
* Company has high book value; shares have high fair market value (FMV).
### Section 56(2)(vii) - Tax on Receipt of Shares Without Consideration:
* If a person receives shares **without consideration** or for inadequate consideration, the **difference between FMV and consideration received** is taxed as **Income from Other Sources** in the hands of recipient.
* So if Mr.P (or any shareholder) receives shares as a gift or nil consideration, this difference may be taxable.
### For Mr.S and Mr.R (Transferors):
* Transferring shares at nil consideration leads to **capital loss**.
* Capital loss can be set off against capital gains subject to provisions of Income Tax Act.
### For Company:
* If company buys back shares at FMV, company pays consideration and there is no income tax implication.
* If shares are forfeited or cancelled, no direct tax implication to company except on capital gains if any.
---
## 3. Recommendations to Avoid Undue Tax Burden
| Issue | Suggested Approach | Reasoning |
| ---------------------------------------------- | --------------------------------------------------- | ------------------------------------- |
| Returning shares to Company | Use **buy-back** procedure at FMV | Legal and tax compliant |
| Returning shares at nil consideration | Transfer shares to other shareholders (Mr.P) at FMV | Avoid Section 56(2)(vii) implications |
| Shareholder resigning and giving up shares | Sell shares at FMV to avoid gift implications | Proper valuation is key |
| Company issuing new shares (private placement) | Comply with valuation and pricing regulations | Avoid tax and regulatory issues |
---
## 4. Summary
| Party | Action | Tax & Legal Impact |
| ----------------------------------- | ------------------------------------------------ | -------------------------------------------------------------- |
| Mr.S / Mr.R | Sell shares at FMV to Mr.P or company (buy-back) | Capital gains tax for transferor; no income tax for transferee |
| Company | Buy-back at FMV | Compliant with law, no tax liability |
| Mr.P | Receives shares at FMV | No income tax liability |
| Share transfer at nil consideration | Taxable under Section 56(2)(vii) | To be avoided |
---
## 5. Additional Notes
* **Proper valuation by a registered valuer is essential** to determine FMV.
* All transactions should be **documented and recorded properly**.
* **Consult company secretary / legal advisor** to comply with procedural aspects of buy-back and share transfer.
* For tax, maintain **proof of consideration, valuation reports, agreements**.
---
If you want, I can help draft a **step-by-step plan for buy-back or share transfer** compliant with Companies Act and Income Tax laws. Would that be helpful?
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