Case Note & Summary
The appeal arose from a certificate granted by the Gujarat High Court against its judgment upholding capital gains tax on reduction of preference share capital. The assessee, an individual shareholder, had purchased 90 non-cumulative preference shares of Sarabhai Limited, each with face value Rs. 1,000, at Rs. 420 per share. In 1965, the company reduced share capital under Section 100(1)(c) of the Companies Act by paying Rs. 500 per share, reducing face value to Rs. 500. In 1966, a second reduction occurred: at an extraordinary general meeting held on 10 January 1966, a special resolution reduced liability on preference shares from Rs. 500 to Rs. 50 per share by paying Rs. 450 per share in cash. The Income Tax Officer taxed the Rs. 450 per share received as capital gains, including Rs. 23,490 in the assessment. The Appellate Assistant Commissioner allowed the assessee's appeal, holding the amount not liable. The Income Tax Appellate Tribunal restored the ITO's order. On reference, the Gujarat High Court answered the question in favor of the Revenue, holding that reduction of preference share capital gave rise to capital gains exigible to tax. The Supreme Court considered whether reduction of share capital with payment of part of capital by reducing face value resulted in extinguishment of rights and thus transfer under Section 2(47) of the Income Tax Act, 1961, attracting Section 45. The appellant contended that reduction did not amount to extinguishment or sale, relying on Commissioner of Income-tax v. R.M. Amin. The Revenue relied on Anarkali Sarabhai v. CIT, where redemption of preference shares was held taxable. The Court held that Section 2(47) is an inclusive definition covering relinquishment of asset or extinguishment of any right therein. Reduction of face value proportionately extinguished the shareholder's rights to dividend, share capital, and distribution on liquidation, and also reduced voting rights under Section 87(2) of the Companies Act. R.M. Amin was distinguishable as involving liquidation distribution. The decision in Anarkali Sarabhai, which held redemption of preference shares amounted to sale/relinquishment, applied equally to partial reduction. Accordingly, the appeal was dismissed, affirming that the amount received on reduction of preference share capital was taxable as capital gains. No costs were awarded.
Headnote
A) Income Tax - Capital Gains - Transfer Defined Extensively - Income Tax Act, 1961, Section 2(47) - Reduction of face value of preference shares from Rs. 500 to Rs. 50 by paying Rs. 450 per share extinguished proportional rights of dividend, share capital, and liquidation distribution, amounting to extinguishment of rights and hence transfer. Held that transfer under Section 2(47) is inclusive and covers extinguishment of any right in a capital asset without requiring a sale (Paras 1-5). B) Income Tax - Capital Gains - Chargeability on Extinguishment - Income Tax Act, 1961, Section 45 - Any profit or gain arising from transfer of a capital asset is chargeable under Section 45; the amount received on reduction of share capital represented gains from extinguishment of rights in preference shares and was taxable as capital gains. Held that the assessee was liable to capital gains tax on Rs. 450 per share received (Paras 1-5). C) Company Law - Reduction of Share Capital - Permissible Procedure - Companies Act, 1956, Section 100(1)(c) - Company validly reduced its preference share capital by special resolution and paid off Rs. 450 per share, reducing face value from Rs. 500 to Rs. 50. Held that such reduction was a mode of capital reduction recognised by law and resulted in proportionate extinguishment of shareholder rights (Paras 1-5). D) Precedent - Applicability of Anarkali Sarabhai - Partial Reduction vis-à-vis Full Redemption - Income Tax Act, 1961, Sections 2(47), 45 - Supreme Court in Anarkali Sarabhai v. CIT held redemption of preference shares was sale/relinquishment and taxable; only difference from present case was full redemption versus partial reduction of face value. Held that the same principle applied to partial reduction, with extent of extinguishment being partial (Paras 1-5). E) Voting Rights - Extinguishment of Rights - Reduction of Voting Power - Companies Act, 1956, Section 87(2) - Reduction in face value of preference shares proportionately reduced voting rights on poll under Section 87(2)(c), constituting further extinguishment of rights and transfer. Held that reduction of voting rights also supported finding of transfer (Paras 1-5). F) Precedent - Distinguishing R.M. Amin - Liquidation Distribution - Income Tax Act, 1961, Sections 2(47), 45 - R.M. Amin involved receipt of money on liquidation representing return of share capital, not extinguishment of rights through reduction; hence not applicable. Held that R.M. Amin was distinguishable and did not assist assessee (Paras 1-5).
Issue of Consideration
Whether reduction of share capital with the company paying a part of the capital by reducing face value of its shares results in extinguishment of right in the shares held by the shareholder so that the amount paid on reduction of share capital is exigible to capital gains tax.
Final Decision
Appeal dismissed. The Supreme Court affirmed the Gujarat High Court's decision that reduction of preference share capital from Rs. 500 to Rs. 50 per share by paying Rs. 450 per share resulted in extinguishment of rights and was a transfer under Section 2(47) of the Income Tax Act, 1961, and the amount received was taxable as capital gains under Section 45. No costs were awarded.
Law Points
- Reduction of share capital by paying off part of face value results in extinguishment of shareholder's rights and is a transfer under Section 2(47) of Income Tax Act
- 1961
- profits arising are chargeable to tax under Section 45
- partial reduction attracts same principles as full redemption in Anarkali Sarabhai
- reduction of voting rights under Section 87(2) Companies Act
- 1956 also amounts to transfer.
