This article on ‘Reduction of Share Capital under Company Law: All you need to know‘ was written by, Shudhi Malhotra an intern at Legal Upanishad.
Chapter IV of the Companies Act of 2013 includes Section 66. It essentially lays out and covers the details behind a company’s share capital reduction. This section outlines the procedures a corporation must follow to lower its share capital and provides disclosures for doing so. Every corporation decreasing its share capital is required to follow this. Except when authorized by the tribunal, a reduction in share capital is illegal.
The company’s share capital is the only security that the creditors have, and it is jealously guarded because any decrease in it affects the fund from which they will be paid. However, Section 66 of the Act of 2013 offers restricted authority for share capital reduction for general necessity. This research will include detailed information regarding the process and disclosure requirements for reducing share capital as well as significant judicial rulings on the subject.
Reasons for the reduction of share capital
A reduction of the share capital may be necessary to pay off debt, cover capital expenses, distribute assets to shareholders, offset trading costs, etc. Most businesses have more resources and reserves than they can use. Furthermore, the financial situation of the organization is not accurately displayed while it is experiencing losses. The assets on the balance sheet may be fictional and have overstated debit balances in the profit and loss account. This portion will need to be written off in this case to lower the share capital; only then will the balance sheet appear favourable.
Methods of the reduction of share capital
- Extinguish or decrease the liability
By lowering or eliminating the penalty on any of its partially paid-up shares, the corporation may lower the share capital. For instance, if the shares have a face value of Rs. 100 each, but only Rs. 50 has been paid, the firm may decrease them to Rs. 50 fully paid-up shares, relieving the shareholders of responsibility for the Rs. 50 uncalled capital per share.
- Rescind any paid-up share capital
By rescinding any shares that have been forfeited or are not described by available assets, the firm may reduce the share capital. For instance, assets worth Rs. 75 would be used to represent shares with a face value of 100 Indian rupees each fully paid-up share. In this scenario, the share capital may be decreased by cancelling shares worth Rs. 25 and deducting equivalent assets.
- Pay off any paid-up share capital
To lower the share capital, the corporation may pay off fully paid-up shares that are more than it desires. For instance, by repaying Rs. 25, fully paid-up shares with a face value of Rs. 100 each might be reduced to Rs. 75 each.
Procedure for Reduction of Share Capital
Decide the date of the company’s general meeting to obtain the permission of the members; Call a Board Meeting to approve the decrease of share capital. All shareholders must receive notification of the general meeting at least 21 days in advance. Hold the general meeting and approve the decrease of share capital with a special resolution. Take a written NOC from any secured creditors you may have. Within 30 days of the passing, submit the Special Resolution and the electronic version of the MGT-14 to the ROC. Within 15 days of the application’s submission, the NCLT is required to notify the ROC, SEBI, and each creditor of the firm in Form RSC-3.
The NCLT must also offer instructions on the publication of the notice in Form RSC-4 in a reputable English- and regional-language newspaper and its upload to the company’s website within seven days of receiving those instructions. If every creditor has been released, secured, or provided his written approval, the NCLT may forgo the notice to creditors requirement and the publication requirement.
Within three months of receiving the notice, the NCLT must receive representation from the ROC, SEBI, and creditors. A copy of this representation must also be sent to the company. If NCLT does not receive such a representation within the allotted time, it is assumed that they do not oppose it. Within 7 days of the objection-seeking period’s expiration, the corporation must transmit any representations or objections it has received together with its reply.
The NCLT may conduct any investigation into the decision regarding a claim and/or guide for securing the creditors’ debts. Form RSC-6 must be used for the order confirming the reduction in share capital. Within 30 days after obtaining the order, the firm must file E-form INC-28 and provide a certified copy of the NCLT’s order under subsection (3) and the minutes that have been ratified by the Tribunal to the ROC. A certificate in Form RSC-7 to that effect must be issued by the ROC.
The Implications under the income tax act
The privileges of the shareholder are destroyed to the capacity that share capital is decreased when a firm decreases its share capital by reducing the face value of its shares or by paying off a portion of the share capital. As a result, it is recognized as a transfer for taxation purposes under section 2(47) of the IT Act.
The income from the capital reduction would be subject to the following taxation:
- Section 2(22)(d) states that amounts allocated by the firm on the capital deduction to the extent of its accumulated profits are deemed dividends, and the corporation must pay the dividend distribution tax on those amounts.
- The shareholders would be responsible for paying capital gains tax on any distribution over and above the accrued earnings over the initial cost of purchasing shares.
Marwari Stores Ltd. v. Gouri Shanker Goenka
The interests of the shareholders must be protected by the court. The recommended reduction plan must be equitable and reasonable for all classes of firm owners. If all of the company’s shares of a single class are to face the reduction equitably, then the plan is fair and has to be approved. The defendant corporation in this case has a capitalization of Rs. 1,92,000 divided into 1920 shares, each worth Rs. 100.
The firm decided to decrease the share capital to half by passing a special resolution. In other words, Rs. 50 of the paid-up share capital on each share was to be cancelled. According to the shareholder who filed the petition, there hasn’t been any capital loss, so the reduction isn’t necessary.
According to the court, the fact that the company seeking the reduction has officially issued a special resolution to that effect suffices as proof that the plan of reduction has been approved rather than just the existence of a real capital loss.
Section 66 of the Companies Act, 2013, offers a safe procedure for this when it becomes necessary for a corporation to decrease its capital. A reasonable mechanism has been established specifically to safeguard creditors from harm when a business’s share capital is reduced, as this has a direct influence on the creditors of that company. To achieve an effective reduction of the company’s capital, three considerations must be made.
The three requirements are as follows: the capital deduction of the shares must be reasonable and unbiased; the approval of the capital reduction must be obtained from the majority of the minority shareholders, and the valuation of the shares must be conducted using a fair methodology.
It becomes challenging for the courts to ascertain the rationale behind the decrease in the firm share capital (be it rearranging its balance sheet or inducing to turn out the minority shareholders). In any case, the corporation must demonstrate that lowering its share capital won’t have any negative effects on the minority shareholders.
- Dhaval Gusani, Reduction of Share Capital, TaxGuru, 27 October 2018, available at: https://taxguru.in/company-law/reduction-share-capital.html
- Palak Gupta, How to carry out reduction of share capital without sanction of the court : an overview, iPleaders Blog, 11 November 2021, available at: https://blog.ipleaders.in/how-to-carry-out-the-reduction-of-share-capital-without-the-sanction-of-the-court-an-overview/
- Palak Dheer, Section 66: Reduction of Share Capital, Ninja Company, 29 April 2020, available at: https://thecompany.ninja/section-66-reduction-of-share-capital/