Supreme Court: Share Capital Reduction Constitutes Capital Asset Transfer Under Income Tax Law
Last Updated on January 11, 2025 by Amit Patra
In a landmark judgment on corporate restructuring and taxation, the Supreme Court has ruled that even where there is no change in the face value of the shares, a reduction in share capital does come under the definition of ‘transfer of capital asset’ under Section 2(47) of the Income Tax Act, 1961.
The investment company suffered long-term capital loss for dilution of shares in Asianet News Network Pvt. Ltd. which was in the incurring losses. But the assessing officer rejected the claim, and then various stages of determining another lower authority could not come to a conclusion; the case subsequently came before the Supreme Court.
The bench including Justices J.B. Pardiwala, and R. Mahadevan iterated, Section 2(47) does not require that transfer be defined in terms of sales. The Court held that, in a situation of reduced share capital, taxpayer status as a shareholder notwithstanding, some rights would be unavoidably extinguished. Rights that would be extinguished would include, but would not be limited to, claims for dividends, share capital, and distributions or residues of net assets upon liquidation.
According to precedents like Kartikeya V. Sarabhai (1997) and Anarkali Sarabhai v. CIT (1997), the Court strongly propounded a proposition that simply by selling one’s holding, a capital gain cannot necessarily be said to have arisen. The judgment emphasized that renunciation or end of rights, without a sale constituted transfer under the Act. This ensures that all such transfers are liable to tax under Section 45.
The Court’s reasoning was predicated on the validity that even though the face value per share may remain unchanged, minimization in total share capital means a corresponding reduction in the rights of the shareholder. The Court, thus, concluded that this reduction in the rights amounts to transfer as understood within Section 2(47).
This ruling makes huge waves in the fields of corporate restructuring and tax planning. It provides great clarity on such capital reduction schemes regarding their tax treatments, and it specifies that these transactions do, even without a classic sale or exchange, generate capital gains provisions. The verdict bends substance over form in tax matters, especially with regard to intricate corporate transactions in which rights are altered or removed without actual sale or transfer in real terms.