Sections 2(47), 45 – A cancellation of shares consequent to reduction of capital constitutes a ‘transfer’ – Loss arising from the cancellation of shares is entitled to indexation and is allowable as a long-term capital loss – The fact that the percentage of shareholding remains unchanged even after the reduction is irrelevant

3. Carestream Health Inc. vs. DCIT (Mumbai)

M. Balaganesh (A.M.) and Amarjit Singh (J.M.)

ITA No.: 826/Mum/2016

A.Y.: 2011-12

Date of order: 6^th February, 2020

Counsel for Assessee / Revenue: Nitesh Joshi / Padmapani Bora

Sections 2(47), 45 – A cancellation of shares consequent to
reduction of capital constitutes a ‘transfer’ – Loss arising from the
cancellation of shares is entitled to indexation and is allowable as a
long-term capital loss – The fact that the percentage of shareholding remains
unchanged even after the reduction is irrelevant

FACT

The assessee was a company
incorporated in and a tax resident of the United States of America. It made
investments to the extent of 6,47,69,142 equity shares of the face value of Rs.
10 each in Carestream Health India Private Limited (CHIPL), its wholly-owned
Indian subsidiary. During the previous year relevant to the assessment year
under consideration, viz. A.Y. 2011-12, CHIPL undertook a capital reduction of
its share capital pursuant to a scheme approved by the Bombay High Court. Under
the capital reduction scheme, 2,91,33,280 shares (out of the total holding of
6,47,69,142 shares) held by the assessee were cancelled and a total
consideration amounting to Rs. 39,99,99,934 was received by the assessee towards
such cancellation / capital reduction. This consideration sum of Rs.
39,99,99,934 worked out to Rs. 13.73 for every share cancelled by CHIPL. This
was also supported by an independent share valuation report.

As per the provisions of section
2(22)(d), out of the total consideration of Rs 39,99,99,934, the consideration
to the extent of accumulated profits of CHIPL, i.e., Rs. 10,33,11,000 was
considered as deemed dividend in the hands of the assessee. Accordingly,
Dividend Distribution Tax (DDT) on such deemed dividend @ 16.609% amounting to
Rs. 1,71,58,924 (10,33,11,000 * 16.609%) was paid by CHIPL. Since the aforesaid
sum of Rs. 10,33,11,000 suffered DDT u/s 115-O, the assessee claimed the same
as exempt u/s 10(34) in the return of income. The balance consideration of Rs.
29,66,88,934 was appropriated towards sale consideration of the shares and
capital loss was accordingly determined by the assessee as prescribed in Rule
115A to Rs. 3,64,84,092 and a return was filed claiming such long-term capital loss.
Thus, the assessee had claimed long-term capital loss of Rs. 3,64,84,092 upon
cancellation of the shares held by it in CHIPL pursuant to reduction of capital
in the return of income for the year under consideration.

The A.O. held that there was no transfer
within the meaning of section 2(47) in the instant case. He observed that the
assessee was holding 100% shares of its subsidiary company and during the year
it had reduced its capital. The assessee company had 100% shares in the
subsidiary company and after the scheme of reduction of capital also, the
assessee was holding 100% of the shares. According to the A.O., this clearly
establishes that by way of reduction of capital by cancellation of the shares,
the rights of the assessee do not get extinguished. The assessee, both before
and after the scheme, was having full control over its 100% subsidiary. The
conditions of transfer, therefore, were not satisfied. Further, the shares have
been cancelled and are not maintained by the recipient of the shares.

Before the A.O. the assessee also
made an alternative argument of treating the same as a buyback. The A.O.
observed in this regard that since the assessee had taken approval from the
High Court for reduction of capital, the same cannot be treated as a buyback.
He, therefore, disallowed the claim of long-term capital loss in the sum of Rs.
3,64,84,092 due to indexation and also did not allow it to be carried forward.

The assessee filed objections before
the DRP against this denial of capital loss. The DRP disposed of the objections
of the assessee by holding that the issue in dispute is covered by the decision
of the Special Bench of the Mumbai Tribunal in the case of Bennett
Coleman & Co. Ltd. reported in 133 ITD 1. Applying
the ratio laid down in the said decision, the DRP observed that the
share of the assessee in the total share capital of the company as well as the
net worth of the company would remain the same even after capital reduction /
cancellation of shares. Thus, there is no change in the intrinsic value of the
shares and the rights of the shareholder vis-a-vis the other
shareholders as well as the company. Thus, there is no loss that can be said to
have actually accrued to the shareholder as a result of the capital reduction.

Pursuant to this direction of the
DRP, the A.O. passed the final assessment order on 23^rd December,
2015 disallowing the long-term capital loss of Rs. 3,64,84,092 claimed by the
assessee in the return of income.

Aggrieved, the assessee preferred an
appeal to the Tribunal.

HELD

At the outset, the Tribunal noted
that the assessee had incurred capital loss only due to claim of indexation
benefit and not otherwise. The benefit of indexation is provided by the statute
and hence there cannot be any mala fide intention that could be
attributed to the assessee in claiming the long-term capital loss in the said
transaction.

As regards the contention of the A.O.
that there is no transfer pursuant to reduction of capital, the Tribunal
observed that –

i) it
is a fact that the assessee had indeed received a sale consideration of Rs.
39.99 crores towards reduction of capital. This sale consideration was not
sought to be taxed by the A.O. under any other head of income. The Tribunal
held that this goes to prove that the A.O. had indeed accepted this to be the
sale consideration received on reduction of capital under the head ‘capital
gains’ only, as admittedly the same was received only for the capital asset,
i.e., the shares. The Tribunal held that the existence of a capital asset is proved
beyond doubt. The capital gains is also capable of getting computed in the
instant case as the cost of acquisition of the shares of CHIPL and the sale
consideration received thereon are available. The Tribunal held that the
dispute is, how is the A.O. justified in holding that the subject mentioned
transaction does not tantamount to ‘transfer’ u/s 2(47).

ii) there
is a lot of force in the argument advanced by the A.R. viz. that merely because
the transaction resulted in loss due to indexation, the A.O. had ignored the
same. Had it been profit or surplus even after indexation, the A.O. could have
very well taxed it as capital gains.

The ratio that could be
derived from the decision of the Hon’ble Supreme Court in CIT vs. G.
Narasimhan reported in [236 ITR 327 (SC)], is that
reduction of capital amounts to transfer u/s 2(47). Even though the shareholder
remains a shareholder after the capital reduction, the first right as a holder
of those shares stands reduced with the reduction in the share capital.

The Tribunal observed that it is not
in dispute that in the instant case the assessee had indeed received
consideration of Rs. 39.99 crores towards reduction of capital and whereas in
the facts of the case before the Mumbai Special Bench reported in 133 ITD
1 relied upon by the DR, there was no receipt of consideration at all.
Out of the total consideration of Rs. 39.99 crores arrived @ Rs. 13.73 per
share cancelled in accordance with the valuation report obtained separately, a
sum of Rs. 10.31 crores has been considered by the assessee as dividend to the
extent of accumulated profits possessed by CHIPL as per the provisions of
section 2(22)(d) and the same has been duly subjected to dividend distribution
tax. The remaining sum of Rs. 29.67 crores has been considered as sale
consideration for the purpose of computing capital gain / loss pursuant to
reduction of capital.

The most crucial point of distinction
between the facts of the assessee and the facts before the Special Bench of the
Mumbai Tribunal was that in the facts before the Special Bench, the Special
Bench was concerned with a case of substitution of one kind of share with
another kind of share, which has been received by the assessee because of its
rights to the original shares on the reduction of capital. The assessee got the
new shares on the strength of its rights with the old shares and, therefore,
the same would not amount to transfer. For this purpose reference has been made
to section 55(2)(v). According to the Special Bench, the assessee therein will
take the cost of acquisition of the original shares as the cost of substituted
shares when capital gains are to be computed for the new shares.

In the present case section 55(2)(v)
has no application. The cost of acquisition of 2,91,33,280 shares shall be of
no relevance in the assessee’s case at any later stage. In paragraph 23 at page
13 of the decision of the Special Bench, it has been observed that though under
the concept of joint stock company the joint stock company is having an
independent legal entity, but for all practical purposes the company is always
owned by the shareholders. The effective share of the assessee in the assets of
the company would remain the same immediately before and after reduction of
such capital. It has thus been observed that the loss suffered by the company
would belong to the company and that cannot be allowed to be set off in the
hands of the assessee.

The law is now well settled by the
decision of the Hon’ble Supreme Court in the case of Vodafone
International Holdings B.V [341 ITR 1] wherein it was held that the
company and its shareholders are two distinct legal persons and a holding
company does not own the assets of the subsidiary company. Hence, it could be
safely concluded that the decision relied upon by the DR on the Special Bench
of the Mumbai Tribunal in 133 ITD 1 is factually distinguishable
and does not come to the rescue of the Revenue.