Reduction of Share Capital

Reduction of share capital under Section 66 of the Companies Act, 2013 , involves reducing the issued, subscribed, and paid-up share capital of a company.  Such reduction can take on different forms, such as with or without payout, and can be selective for a specific class of shares. However, it does  not include buy-back of shares.

Share Capital Reduction – Relevant Sections	Section 66 of the Companies Act, 2013 Section 2(22)(d) of Income Tax Act, 1961
Modes of Capital reduction – Section 66	Extinguishment of shares Cancellation of shares Pay off
Officer committing certain acts can be liable under which Section	Section 447 of the Companies Act, 2013
Authority for Confirmation of Share Capital Reduction	National Company Law Tribunal (NCLT)
Certificate issued for confirmation of order by	Registrar of Companies (ROC)

Introduction to Capital Reduction

Companies often use share capital reduction as a means of internal restructuring or adjusting their capital structure.

There are various reasons why a company may opt for capital reduction, including reducing accumulated losses, cancelling the capital of certain shareholders, or refunding surplus funds available with the company to shareholders.  Capital reduction process involves understanding of corporate laws, accounting, and tax . In this Article we would be discussing the intricacies relating to these aspects : –

What is Capital reduction ?

A company may have different classes of share capital, which may be fully or partly paid up. The reduction in share capital is a process , under which a company decreases its share capital. The capital which is reduced  can be issued capital or subscribed capital or paid-up capital. The share capital reduction is dealt with under Section 66 of the Companies Act, 2013.

The following companies can undertake share capital reduction by passing a  special resolution   : –

1. Company limited by shares ;
2. Company limited by guarantee which has a share capital.

Capital reduction has to be approved by National Company Law Tribunal (“NCLT”).

Purpose of Reduction of Share Capital

The purpose of reduction of share capital can be either of the following : –

• Eliminating accumulated losses : –  It helps in eliminating accumulated losses that have made it difficult to raise capital or pay dividends.
• Simplifying the capital structure: It helps the company to simplify its capital structure , by reducing the number of  outstanding shares, consolidating shares, or making other changes to the share capital.
• Returning surplus capital to shareholders : A company can return surplus capital to shareholders in the form of cash payments.
• Increasing return on equity:  A company can increase the return on equity for shareholders by reducing the amount of capital .

Methods of Share Capital Reduction in India

A company can undertake reduction of share capital  through : –

• Extinguishment of shares: The company can extinguish or reduce the liability of its shares where share capital is not paid-up. For instance, the face value of certain equity shares is Rs. 500, out which Rs. 400 has already been paid-up. In such a case, the company can extinguish the remaining liability of Rs. 100 and can forgo the payment of the uncalled capital.
• Cancellation of shares : A company can cancel its paid-up shares , which are not available as assets, or have  lost  value. It can be with or without extinguishing the shares or reducing liability. Let’s take an example. Suppose, fully paid up shares of Rs, 200 each, represent assets worth Rs. 100. As a result, the company can cancel shares worth Rs. 100 and write-off assets of similar value, which is generally the debit balance of profit and loss account.
• Pay-off: A company may pay off its paid-up shares if it is in excess by or without extinguishing the shares or reducing liability. For example, if value of fully paid up shares of Rs. 100, it can be reduced to Rs. 60 and balance Rs. 40 can be returned to shareholders.

Capital Reduction can be undertaken  in following cases

• Section 66 of the Companies Act, 2013 through extinguishment, cancellation or pay off
• Through a scheme of compromise or arrangement under Section 230 of the Companies Act, 2013
• In case of oppression and management under Section 242 of the Companies Act, 2013
• SEBI (LODR) Regulations, 2015 for listed companies

Capital Reduction cannot be undertaken  in following cases

A company cannot undertake capital reduction when, it is   :

• • The company is in arrears for repayment of any deposit
  • The company has arrears in payment of interest on deposit

What is the Process of Reduction of Share Capital

The process for share capital reduction in India is as follows : –

Activities from the Company

1. Article of Association (AOA) of the company : The AOA of the company must provide for reduction of the share. If it is not provided, then the alteration of the AOA has to take place under Section 14 of the Companies Act, 2013.
2. Board Resolution and shareholder’s approval: The Board of Directors has to pass a resolution recommending the reduction in share capital. The shareholders must approve the reduction by passing a special resolution in the general meeting.
3. Filing of application with the ROC: The company has to file Form MGT-14 within 30 days of the Special Resolution with the Registrar of Company (ROC).
4. Filing of application with National Company Law Tribunal (NCLT): An application in Form RSC-1 is to be filed with NCLT for confirmation of capital reduction with a fee of Rs. 5000.

Post Filing Activities

1. Notice by NCLT: NCLT will give notice of the application of capital reduction within 15 days to:
   • Central Government (Form RSC-2)
   • Registrar of Companies (Form RSC-2)
   • Securities and Exchange Board of India – SEBI (only in case of listed companies) (Form RSC-2)
   • Creditors of the company – Notice within 7 days (Form RSC-3)
2. Publication of Notice of NCLT: The company must publish notices in Form RSC-4 within 7 days in at least one English newspaper and one vernacular newspaper in the State.
3. Affidavit to be filed by the company: The company will file an affidavit in Form RSC-5 to confirm the dispatch and publication of the notice.
4. Objection period and resolution: The NCLT will provide time for representation by stakeholders.
   • Representation  made within 3 months  shall be considered.
   • Where no representation is received from stakeholders within 3 months, it is assumed that there is no objection .
5. Final Order of Confirmation by NCLT : Once NCLT is satisfied that the claims on the company or debts of creditors are secured , it shall pass  final order of reduction of share capital  in Form RSC-6 .

Activities Post NCLT Order

1. Filing Certified copies of the NCLT order with ROC: The certified copy of the NCLT order is  filed with ROC in the Form INC-28 within 28 days of the order.
2. Certificate of effect by ROC: After delivering the certified copies of the order, ROC will register the reduction and issue a certificate as per Form RSC-7.

Tax implications of Capital Reduction

The tax implications on account of Capital Reduction in hands of various parties is as under : –

• Deemed Dividend:  Section 2(22)(d) of the Income Tax Act, 1961 , provides that reduction of capital by the company would be considered as distribution of dividend . Such distribution of dividend would be taxable in the hands of the shareholders . However, the quantum treated as dividend would be restricted to the extent of accumulated profits.
• Taxed in the hands of the shareholders : – Distribution in excess of Accumulated profits, will be taxable in the hands of the shareholders as capital gains tax. However, to compute such gains, reduction shall be allowed for the cost of acquisition in the hands of the shareholders. Further, in case of a non-resident shareholder, he shall be eligible to claim the benefit of tax Treaty, or opt for taxation under the provision of IT Act, whichever are more beneficial.

• Capital reduction on accumulated losses : – Where a company undertakes, capital reduction without payout, any Long-term capital loss arising to the shareholder, is allowed on capital reduction [Carestream Health INC (2020)]. However, there are certain contrary decision which state otherwise

Landmark Decisions

• In the case of Narasimhan (1999), Madras HC held that when there is a reduction of share capital, it will amount to reduction in rights of shareholders , and it will accordingly amount to transfer within Section 45 of the Income Tax Act, 1961, resulting in capital gains in the hands of the shareholders
• In the case of Kartikeya v. Sarabhai (1997), the Supreme Court held that where there is reduction in the face value of the shares, it would lead to extinguishment of the rights and the amount will be taxed as ‘capital gains’.

Conclusion

Reduction of share capital can undertake different forms and have different compliance and tax implications in the hands of shareholders and company. In certain cases, to repatriate excess funds, company can evaluate alternate mechanism like buyback and dividend distribution reduction.

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