1997 (9) TMI 2 - SC - Income Tax

Lowering share face value extinguishes shareholder rights and amounts to a 'transfer' under section 2(47), taxable under section 45

SC held that reduction of share capital by lowering face value proportionately extinguishes parts of a shareholder's rights (dividend entitlement, ... Transfer - extinguishment of rights - reduction of share capital - capital gains - redemption / buy-back of preference sharesTransfer - extinguishment of rights - reduction of share capital - capital gains - Whether the payment received by the shareholder on reduction of the face value of preference shares amounted to a transfer within the meaning of section 2(47) of the Income-tax Act and gave rise to taxable capital gains under section 45 - HELD THAT: - The Court held that the definition of 'transfer' in section 2(47) is inclusive and covers not only sale but also relinquishment of an asset or extinguishment of rights therein. A reduction of the face value of preference shares under the Companies Act which results in the company paying cash to the shareholder effects a proportional extinguishment of the shareholder's rights - including rights to dividend and to share in distribution on liquidation and a corresponding reduction in voting power where relevant. That extinguishment or relinquishment of part of the shareholder's rights is a mode of transfer contemplated by section 2(47), and any profit or gain arising therefrom is chargeable under section 45. The Court applied and followed this reasoning as laid down in Anarkali Sarabhai v. CIT, holding that even a partial redemption (reduction of capital) which extinguishes rights to the extent of the reduction brings the transaction within the charge of capital gains. The decision in R. M. Amin was distinguished: distributions in liquidation represent satisfaction of existing rights rather than a transaction amounting to sale or extinguishment for purposes of section 2(47), whereas reduction of capital by payment and surrender of rights operates as a transfer.The amount received on reduction of the face value of the preference shares constituted proceeds of a transfer (extinguishment of rights) and was exigible to capital gains tax.Final Conclusion: Appeal dismissed; the sum received on reduction of the preference share capital is taxable as capital gains. Issues Involved:1. Whether the reduction of share capital by reducing the face value of shares constitutes an extinguishment of rights in the shares held by the shareholder.2. Whether the amount paid on the reduction of share capital is exigible to capital gains tax under the Income-tax Act, 1961.Detailed Analysis:Issue 1: Reduction of Share Capital and Extinguishment of RightsThe primary issue is whether the reduction of share capital by decreasing the face value of shares results in the extinguishment of rights in the shares held by the shareholder. The appellant had purchased 90 non-cumulative preference shares at Rs. 420 per share, each originally having a face value of Rs. 1,000. In 1965, the face value was reduced to Rs. 500 per share, and the appellant received Rs. 500 in cash per share. Subsequently, in 1966, the face value was further reduced to Rs. 50 per share, and the appellant received an additional Rs. 450 per share in cash.The appellant argued that the reduction of the face value did not amount to the extinguishment of any rights and, therefore, did not constitute a transfer under section 2(47) of the Income-tax Act, 1961. The appellant contended that they continued to be a shareholder of the company and cited the case of CIT v. R. M. Amin [1977] 106 ITR 368 (SC) to support the argument that no transfer occurred.However, the court held that the reduction of share capital does result in the extinguishment of rights. Section 2(47) of the Act includes the 'extinguishment of any rights' as a form of transfer. The court noted that while the appellant remained a shareholder, the reduction in share capital proportionately extinguished the right to dividends and the right to share in the distribution of net assets upon liquidation. The reduction in face value from Rs. 500 to Rs. 50 per share effectively reduced the appellant's rights as a shareholder.Issue 2: Capital Gains Tax ApplicabilityThe second issue is whether the amount received on the reduction of share capital is subject to capital gains tax. The Income-tax Officer initially held that the amount of Rs. 450 per share received by the appellant was liable to capital gains tax. The Appellate Assistant Commissioner reversed this decision, but the Income-tax Appellate Tribunal reinstated the original order, leading to the High Court's involvement.The court referred to section 45 of the Act, which states that any profits or gains arising from the transfer of a capital asset are chargeable to income-tax under the head 'Capital gains.' The definition of 'transfer' under section 2(47) includes the extinguishment of any rights in the capital asset. The court found that the reduction in the face value of shares resulted in the extinguishment of rights, thus constituting a transfer.The court also referred to the case of Anarkali Sarabhai v. CIT [1997] 224 ITR 422 (SC), where it was held that the redemption of preference shares by a company amounted to a sale and was exigible to capital gains tax. The court found the principles in Anarkali's case applicable, noting that the reduction in share capital in the present case similarly resulted in the extinguishment of rights and was thus subject to capital gains tax.The court distinguished the present case from R. M. Amin's case, where the company had gone into voluntary liquidation, and the payment received by the shareholder was not considered a transfer. In contrast, the reduction of share capital in the present case was an active transaction resulting in the extinguishment of rights.In conclusion, the court upheld the High Court's decision that the appellant was liable to pay capital gains tax on the capital gain of Rs. 28,710 resulting from the reduction in preference share capital. The appeal was dismissed with costs.