Category: Direct Taxes

ISSUE FOR CONSIDERATION

Under section 66 of the Companies Act, 2013, a company can reduce its share capital by inter alia cancelling any paid-up share capital which is lost or is not represented by available assets, or for payment of any paid-up share capital which is in excess of the wants of the company, after obtaining the approval of the National Company Law Tribunal (NCLT). The reduction of share capital may be effectuated either by cancelling some shares, or by reducing the paid-up value of all shares. When paid-up share capital which is lost or unrepresented by available assets is reduced, either by cancelling some shares or by reducing the paid-up value of all shares, no consideration is paid to the shareholders, as the share capital is set off against the accumulated losses (debit balance in the Profit & Loss Account).

While the Supreme Court has held that reduction of share capital is a transfer in the hands of the shareholder, in the cases of Kartikeya V. Sarabhai vs. CIT 228 ITR 163 and CIT vs. G Narasimhan 236 ITR 327, and there arose a liability to pay capital gains tax where a consideration was received on reduction of capital the issue has arisen before various benches of the Tribunal as to whether in cases of capital reduction where no amount is paid to the shareholder, whether a capital loss is allowable to the shareholder, since there is no consideration received by him on such reduction.

Special Bench of the Mumbai Tribunal has taken a view that a capital loss is not allowable on reduction of capital without any payment, a recent decision of the Mumbai bench of the Tribunal however has taken the view that in such a case, the shareholder is entitled to claim a loss under the head ‘capital gains’.

BENNETT COLEMAN & CO’S CASE

The issue had come up before the Special Bench of the Mumbai Tribunal in the case of Bennett Coleman & Co Ltd vs. Addl CIT 133 ITD 1(Mum)(SB).

In this case, the assessee had made an investment of ₹2,484.02 lakh in equity shares of a group company, TGL. TGL applied to the Bombay High Court for reduction of its equity share capital by 50 per cent, by reducing the face value of each share from ₹10 to ₹5, which was approved by the High Court. The assessee claimed a capital loss of half its investment, claiming the indexed cost of ₹1,242.01 lakh (₹2,221.85 lakh) as a capital loss.

Before the Assessing Officer (AO), it was claimed that such loss was allowable in view of the decisions of the Supreme Court in the cases of Kartikeya V Sarabhai (supra) and G Narasimhan (supra), where it was held that reduction of face value of shares was a transfer. According to the AO, the decision of the Supreme Court in the case of Kartikeya Sarabhai(supra) could not be applied, because in that case the voting rights were also reduced proportionately on the reduction in face value of preference shares, whereas in the case before him, there was no reduction in the rights of the equity shareholders. According to the AO, since there was no change in the rights of the assessee vis-à-vis other shareholders, no transfer had taken place and thus the assessee was not entitled to the claim of long-term capital loss.

The Commissioner (Appeals) upheld the action of the AO in disallowing the claim for capital loss.

Before the Tribunal, on behalf of the assessee, it was argued that the claim of long-term capital loss had been rejected mainly on the ground that no transfer had taken place. It was pointed out that the accumulated losses of ₹42.97 crore of TGL were written off by the reduction of capital and by utilising the share premium account. Equity shares of ₹10 each were reduced to equity shares of ₹5 each by cancelling capital to the extent of ₹5 per equity share, and thereafter every two such equity shares of ₹5 each were consolidated into one equity share of ₹10 each, under the scheme of reduction of capital. The assessee’s shareholding of 1,34,74,799 shares of ₹10 each was therefore reduced to 67,37,399 shares of ₹10 each. It was argued on behalf of the assessee that the shares received after reduction of capital were credited to the demat account under a different ISIN, which clearly indicated that the new shares were different shares. This was therefore an exchange of shares which was covered by the definition of “transfer”.

On behalf of the assessee it was argued that the Supreme Court had observed in the case of Kartikeya Sarabhai (supra) that the definition of transfer in section 2(47) was an inclusive one, which inter alia provided that relinquishment of an asset or extinguishment of any right therein would also amount to transfer of a capital asset. It was further argued that even if it was assumed that the principle laid down by the Supreme Court in the case of preference shares was not applicable, the principle laid down in the case of G Narasimhan(supra) squarely applied, since the issue in that case was regarding reduction of equity share capital. Reliance was also placed on the decision of the Supreme Court in the case of CIT vs. Grace Collis 248 ITR 323, wherein the Supreme Court observed that the expression ‘extinguishment of any right therein’ could be extended to extinguishment of rights independent of or otherwise than on account of transfer. It was argued that therefore, even extinguishment of rights in a capital asset would amount to transfer, and in the case before the Tribunal, since the assessee’s right got extinguished proportionately due to the reduction of capital, it would amount to transfer.

Attention of the Tribunal was drawn to the following decisions of the Tribunal, where it had been held that reduction of capital would amount to transfer and capital loss was therefore held to be allowable:

Zyma Laboratories Ltd vs. Addl CIT 7 SOT 164 (Mum)

DCIT vs. Polychem Ltd ITA No 4212/Mum/07

Ginners & Pressers Ltd vs. ITO 2010(1) TMI 1307 – ITAT Mumbai

The Bench raised the question that the capital loss had not been disallowed only on the ground that it would not amount to transfer but mainly on the point that the assessee had not received any consideration, by applying the principle laid down by the Supreme Court in the case of CIT vs. B C SrinivasaSetty 128 ITR 294, wherein it was held that if the computation provisions fail, capital gains cannot be assessed under section 45.

Responding to the question, on behalf of the assessee, it was pointed out that in the case of B C Srinivasa Setty (supra), the Supreme Court held that it was not possible to ascertain the cost of goodwill and therefore it was not possible to apply the computation provisions. The proposition was not that if no consideration was received then no gain could be computed, but the proposition was that if any of the elements of the computation provisions could not be ascertained, then the computation provisions would fail, and such gain could not be assessed to capital gains tax. In the case of the assessee, the consideration was ascertainable, and should be taken as zero.

On behalf of the revenue, it was argued that the value of assets of the company remained the same before and immediately after such reduction, and therefore no loss was caused to the assessee. It was argued that a share meant proportionate share of assets of the company, and since share of the assessee in the company’s assets had not gone down, therefore no loss could be said to have been incurred by the assessee. It was argued that reduction of share capital could at best lead to a notional loss.

Attention of the bench was drawn to section 55(2)(v), which defines cost of acquisition in case of shares in the event of consolidation, division or conversion of original shares, as per which clause, original cost had to be taken as cost of acquisition. It was argued that therefore the cost of acquisition would remain the same to the assessee as per this provision.If the loss on reduction of share capital was allowed at this stage, in future if such shares were sold, the assessee could then claim the cost as cost of acquisition, which would be a double benefit to the assessee, which was not permissible under law as laid down by the Supreme Court in the case of Escorts Ltd. vs. Union of India 199 ITR 43.

It was further submitted on behalf of the revenue that whenever a company issued bonus shares, no capital gains was chargeable on the mere receipt of such bonus shares, and capital gains would be charged only when such bonus shares were sold by the assessee. A similar principle needed to be applied in a case when the assessee’s shareholding was reduced on reduction of such capital. It was argued that at best, just as held by the Supreme Court in CIT vs. Dalmia Investment Co Ltd 52 ITR 567that average cost of shares would have to be taken when bonus shares are sold, meaning that the cost of the shares was adjusted and cost of acquisition was taken at average value, the same principle should be applied on reduction of share capital, average cost of holding after reduction of capital would increase, and the loss could be considered only when such shares were transferred for a consideration.

It was argued that this principle has been affirmed by the Supreme Court in the case of Dhun Dadabhoy Kapadia v CIT 63 ITR 651, where the court held that gain was to be understood in a similar way as understood by the commercial world, and receipt on sale of right to subscribe to rights shares was required to be reduced by fall in the value of existing shareholding. Following the same principle, it was argued that at best in the assessee’s case, the value of reduced shareholding could be increased (cost of acquisition could be increased) but the loss could not be allowed, since at the stage of capital it was only a notional loss.

In rejoinder on behalf of the assessee, it was pointed out that no double benefit had been obtained by the assessee, since the cost claimed had been reduced from the value of investment.

The Tribunal referred to the decision of the Supreme Court in the case of CIT vs. Rasiklal Maneklal HUF 177 ITR 198, where shares were received by the assessee in the amalgamated company in lieu of shares held in the amalgamating company. In that case, the Supreme Court had observed that in case of exchange, where one person transfers a property to another person in exchange of another property, the property continues to be in existence. Therefore, the Supreme Court had held that since the shares of the amalgamating company had ceased to be in existence, the transaction did not involve any transfer. Applying those principles to the case before it, the Tribunal observed that if the argument of the assessee was accepted, older shares with different ISIN ceased to exist and new shares with different ISIN were issued, which would not be called a case of extinguishment or relinquishment, but was a mere case of substitution of one kind of share with another. According to the Tribunal, the assessee got its new shares on the strength of its rights with the old shares, and therefore this would not amount to a transfer.

Analysing the decision of the Supreme Court in the case of G Narasimhan(supra), which involved reduction of share capital in respect of equity shares, the Tribunal observed that a careful analysis of this decision indicated that whenever there was reduction of shares and upon payment by the company to compensate the value equivalent to reduction, apart from the effect on shareholders rights to vote, etc, a transfer could be said to have taken place. The question was whether this would still attract section 45.

According to the Tribunal, the answer was given by the Gujarat High Court in the case of CIT vs. MohanbhaiPamabhai 91 ITR 393, where the High Court held that section 48 showed that the transfer that was contemplated by section 45 was a transfer as a result of which consideration was received by the assessee or accrued to the assessee. If there was no consideration received or accruing to the assessee as a result of the transfer, the machinery section enacted in section 48 would be wholly inapplicable, and it would not be possible to compute profits or gains arising from the transfer of the capital asset. According to the High Court, the transaction in order to attract the charge of tax as capital gains must therefore clearly be such that consideration is received by the assessee or accrues to the assesse as a result of the transfer of the capital asset. Where transfer consisted in extinguishment of rights in a capital asset, there must be an element of consideration for such extinguishment, for only then would it be a transfer exigible to capital gains tax. The Tribunal noted that the Supreme Court had dismissed the appeal of the revenue against this decision, which is reported as Addl CIT vs. MohanbhaiPamabhai 165 ITR 166.

Analysing the decision of the Supreme Court in the case of Sunil Siddharthbhai(supra), the Tribunal observed that the court relied upon the principle laid down in the case of CIT vs. B C Srinivasa Setty (supra), and held that unless and until consideration was present, the computation provisions of section 48 would not be workable, and therefore such transfer could not be subjected to tax. The court further held that unless and until the profits or losses were real, the same could not be subjected to tax. Referring to the Supreme Court decision of B C Srinivasa Setty(supra), the Tribunal noted that it was clear that unless and until a particular transaction led to computation of capital gain or loss as contemplated by section 45 and 48, it would not attract capital gains tax.

The Tribunal observed that in the case before it, the assessee had not received any consideration for a reduction of share capital. Ultimately the number of shares held by the assessee had been reduced to 50 per cent, and that nothing had moved from the side of the company to the assessee. Addressing the argument of the assessee that the decision of Mohanbhai Pamabhai (supra) was not applicable, because in this case it was possible to ascertain the consideration by envisaging the same as zero, the Tribunal held that in the case of reduction of capital, nothing moved from the coffers of the company, and therefore it was a simple case of no consideration which could not be substituted to zero. The Tribunal also noted that wherever the legislature intended to substitute the cost of acquisition at zero, specific amendment had been made. In the absence of such amendment, it had to be inferred that in the case of reduction of shares, without any apparent consideration, and that too in a situation where the reduction had no effect on the right of the shareholder with reference to the intrinsic rights on the company, section 45 was not applicable.

The Tribunal rejected the reliance by the assessee on the decision of the Karnataka High Court in the case of Dy CIT vs. BPL Sanyo Finance Ltd 312 ITR 63, a case of claim of loss on forfeiture of partly paid up shares, on the ground that in the case before it, shares had not been cancelled but only the number of shares had been reduced, which was only a notional loss. Further according to the Tribunal, in that case, the decision of the Supreme Court in the case of B C Srinivasa Setty (supra) had not been considered, but it had decided this issue on the basis of the Supreme Court decision in the case of Grace Collis (supra)

Noting the decision of Grace Collis (supra), the Tribunal observed that it was clear that even extinguishment of rights in a particular asset would amount to transfer. It however observed that in the case before it, the assessee’s rights had not been extinguished, since the effective share of the assessee in the assets of the company would remain the same immediately before and after reduction of such capital.

The Tribunal went on to analyse in great detail with illustrations as to how issue of bonus shares by a profit-making company or reduction of capital by a loss-making company did not affect the shareholders rights, because such profit or loss belonged to the company. According to the Tribunal, since the share of the shareholder in the net worth of the company remained the same before and after reduction of capital, there was no change in the intrinsic value of his shares and even his rights vis-à-vis other shareholders as well as vis-à-vis the company would remain the same. Therefore, the Tribunal was of the view that there was no loss that could be said to have actually accrued to the shareholder as a result of reduction in the share capital.

The Tribunal also relied on the decision of the Bombay High Court in the case of Bombay Burmah Trading Corpn Ltd vs. CIT 147 Taxation Reports 570 (Bom), a very short judgment where the facts were not discussed, but the question was answered by the Bombay High Court as being covered by the ratio of the decision of the Supreme Court in the case of B C Srinivasa Setty (supra), and held to be not a referable question of law, as the answer to the question was self-evident. According to the Tribunal, in that case it was held that if no compensation was received, then capital loss cannot be allowed, and that the decision of the jurisdictional High Court could not be ignored by the Tribunal simply because it was assumed that certain aspects of the issue might not have been considered by the jurisdictional High Court.

The Tribunal also relied upon the decision of the Authority for Advance Rulings in the case of Goodyear Tire & Rubber Co, in re, 199 Taxman 121, where the assessee, a US company, propose to contribute voluntarily its entire holding in an Indian company to a Singapore-based group company voluntarily without consideration. The AAR held that no income would arise, as the competition provision under section 48 could not be given effect to, and therefore the charge under section 45 failed, in view of the decisions of the Supreme Court in the case of B C Srinivasa Setty (supra) and Sunil Siddharth bhai (supra).

The Tribunal also agreed with the submissions of the revenue that the provisions of section 55(2)(v) would apply in such a case and that after reduction of share capital, the cost of acquisition of the remaining shares would be reckoned with reference to the original cost.

The Tribunal therefore held that the loss arising on account of reduction in share capital could not be subjected to provisions of section 45 with section 48, and accordingly, such loss was not allowable as capital loss. At best, such loss was a notional loss, and it was a settled principle that no notional loss or income could be subjected to the provisions of the Income Tax Act.

This decision of the Special bench was also followed by another bench of the Mumbai Tribunal in the case of Shapoorji Pallonji Infrastructure Capital Company Pvt Ltd vs. Dy CIT, ITA No 3906/Mum/2019.

TATA SONS’ CASE

The issue again recently came up before the Mumbai bench of the Tribunal in the case of Tata Sons Ltd v CIT 158 taxmann.com 601.

In this case, the assessee held 288,13,17,286 equity shares in TTSL, an Indian telecom company which had incurred substantial losses in the course of its business. A Scheme of Arrangement and Restructuring was entered into by TTSL and its shareholders whereby the paid up equity share capital was to be reduced by reducing the number of equity shares of the company by half, and given effect to by reducing the amount from the accumulated debit balance in the Profit and Loss Account and by a reduction from Share Premium Account. No consideration was payable to the shareholders in respect of the shares which were to be cancelled. The reduction of capital was effected under section 100 of the Companies Act, 1956. As a result of such reduction of capital, the assessee’sshare holding of 288,13,17,286 equity shares in TTSL was reduced to half, i.e. 144,06,58,643 equity shares.

In its return of income, the assessee claimed a long-term capital loss on reduction of the shares of TTSL of ₹2046,97,54,090. During the course of assessment proceedings, in response to a query from the AO, the assessee provided details, the working of the capital gains, and explained how the claim of the assessee for long term capital losses was allowable in view of the decisions of the Supreme Court in the cases of Kartikeya Sarabhai (supra), G Narasimhan (supra) and D P Sandhu Brothers ChemburPvt Ltd 273 ITR 1. It was specifically pointed out that reduction of capital, i.e. loss of shares, was tantamount to a transfer under section 2(47), and that computation provision can fail only if it was not possible to conceive of any element of cost.

A show cause notice was issued by the AO asking as to why corresponding cost of shares on reduction in share capital of TTSL should not be treated as cost of the balance shares of TTSL. The AO asked for further details of capital gains, which was duly provided. After examining the factual and legal submissions, the AO accepted the assessee’s claim for long term capital loss in his assessment order under section 143(3).

The Principal Commissioner of Income Tax (PCIT) initiated revision proceedings under section 263, on various grounds, and held that the assessment order was erroneous and prejudicial to the interests of revenue on the following grounds:

1.  since no consideration had accrued or received as a result of transfer of the capital asset, the provisions of section 48 could not be applied;
2.  the Supreme Court decision in the case of Kartikeya Sarabhai was distinguishable as that was not a case of reduction in the face value of shares but an effacement of the entire shares;
3.  the scheme was claimed as a scheme of arrangement and restructuring but was not a scheme of reduction of capital;
4. the consideration received is ₹ nil and not ₹ zero;
5.  in another company, Tata Power Ltd, the AO had disallowed the capital loss in respect of reduction of share capital/cancellation of shares of TTSL.

The PCIT therefore directed the AO to determine the total income by disallowing the long-term capital loss after giving the assessee an opportunity of being heard.

Before the Tribunal, on behalf of the assessee it was argued that:

1.  the issue had been examined by the AO during assessment proceedings and, if the AO had taken one possible view of the matter, then the CIT could not revise or cancel the assessment order within the scope of section 263;
2.  the PCIT failed to consider that it is possible in law for schemes of reduction of capital to provide for payment of consideration to the holders of the shares; in such cases the Tribunal has held that it is an allowable capital loss, whether or not consideration was payable in terms of the scheme;
3.  the PCIT had based his decision on an entirely incorrect legal principle that the provisions of section 48 failed and therefore no capital loss can be determined in the case where no consideration is received/accrues to the transferor of the capital asset. This was contrary to the well-settled law laid down by the Supreme Court in B C Srinivasa Setty (supra) and D P Sandhu Brothers ChemburPvt Ltd (supra), wherein the correct principle laid down was that the capital gains computation provisions may be held not to apply, if and only if, any part thereof cannot conceivably be attracted. The correct principle is that if it is impossible to conceive of consideration as a result of the transfer, then perhaps it could be argued that the provisions of section 48 do not apply.
4. There is a vast difference between a case where no consideration is conceivable in a transaction, as opposed to a case where nil consideration is received; if it is conceivable that consideration can result, that consideration may be zero or nil or any figure. This is vastly different from no consideration being conceivable.
5. There could be no dispute that the shares held by the assessee had been reduced, which had led to a huge loss to the assessee, which was clearly a capital loss.
6. It was undisputed that the reduction of capital effected under the scheme resulted in cancellation of 144,06,58,653 equity shares of TTSL held by the assessee; such cancellation in extinguishment of the shares clearly amounted to a transfer as defined in section 2(47); the provisions of section 45 were clearly attracted as the shares had been transferred; the provisions of section 48 were also clearly attracted; on a plain reading of the provisions, it was indisputable that a capital loss had arisen as a result of transfer of the shares and consequently allow ability of the capital loss was certainly a possible view, and accordingly the provisions of section 263 could not have been invoked by the PCIT;
7. The view of the PCIT that since no consideration was received by the assessee on reduction of capital, the provisions of section 45 to 48 could not be applied, cannot be termed to be a correct, irrefutable, or definitive view and was not supported by any statutory provision or principle of law or binding judicial precedent.
8. The decision of the Gujarat High Court in the case of CIT vs. Jaykrishna Harivallabhdas 231 ITR 108 holds in favour of the assessee’s contention that the capital loss was to be computed in cases even where no consideration had been received on the transfer of a capital asset.
9.  The order of the Delhi High Court approving the scheme specifically provided that the scheme was one of reduction of capital.

Addressing the conclusion of the PCIT that the computation mechanism under section 48 fails, it was argued on behalf of the assessee that the correct principle was that the capital gains provisions may be held not to apply if and only if any part thereof cannot conceivably be attracted. Although no consideration had been received by or had accrued to the assessee, it was certainly possible to conceive of consideration being received or receivable in such cases, and that the consideration here was zero. Reliance was placed on the decisions of the Tribunal in the cases of Jupiter Capital Pvt Ltd vs. ACIT (ITA No 445/Bang/2018) and Ginners and Pressers Ltd v ITO 2010 (1) TMI 1307 – ITAT MUMBAI for the proposition that when there was a reduction by way of cancellation of shares, it constituted a transfer under section 2(47) and the consequential capital loss was allowable whether or not any consideration was received/receivable by the shareholder.

It was argued on behalf of the assessee that the ITAT Special Bench decision in the case of Bennett Coleman and Co Ltd(supra) was not applicable due to the following reasons:

1. this was a case where section 263 had been invoked where the AO had taken a possible view of the matter, while in Bennett Coleman’s case, there was a dissenting order;
2.  in Bennett Coleman’s case, there was a substitution of shares, which was not the fact in Tata Sons case. This distinction had been noted by the Tribunal in the case of Carestream Health Inc. vs. DCIT 2020 (2) TMI 325 – ITAT Mumbai, where the Tribunal had allowed capital loss on cancellation of shares.

It was pointed out that section 55(2)(v)(b) does not include the situation of cancellation of shares held consequent to reduction of capital, and hence if the cost of the cancelled shares is not allowed in the year of cancellation, it will never be allowed.

On behalf of the revenue, it was submitted that the AO had not examined the correct principle of law on the facts of the case. The judgements relied upon by the assesse in the facts of the case, because none of the cases pertains to loss on reduction of capital. Even if there is a transfer under section 2(47), the computation mechanism fails because there is no cost. On this very issue there was an ITAT Mumbai Special Bench Decision in the case of Bennett Coleman(supra), which had considered all the judgements of the Supreme Court cited by the assessee, and had categorically held that in the case of reduction of capital, if no consideration can be determined, then the computation mechanism fails. In view of this decision of the Special Bench, it was submitted that the claim of the assessee cannot be upheld, because capital gain / loss cannot be determined.

Looking at the facts, the Tribunal observed that there could be no dispute that there was a loss on the capital account by way of reduction of capital invested, and therefore any loss on capital account was a capital loss. The issue therefore was whether it was a notional loss, and even if it was a capital loss whether the same could be allowed because no consideration had been received by or accrued to the assessee.

The Tribunal analysed the provisions of section 100(1) of the Companies Act, 1956, which provided for the manner in which reduction of capital could be effected. This also envisaged payment of any paid up capital which was in excess of the wants of the company. Thus, the Tribunal noted that there could be a case where the consideration was paid on the reduction of capital, or there could be a case where consideration was not paid at all. The Tribunal questioned as to whether, in such circumstances, two views could be taken in the reduction of capital, one where certain consideration was paid, and another where no consideration was paid. For instance, if the assessee had received a nominal consideration, then it would be entitled to claim the capital loss. Not allowing such loss just because the assessee had not received any consideration, was a reasoning which the Tribunal expressed its inability to accept.

The Tribunal noted that the issue of whether the reduction of face value of shares amounted to transfer or not had been settled by the Supreme Court in the case of Kartikeya Sarabhai(supra), where the court held that it was not possible to accept the contention that there had been no extinguishment of any part of the right as a shareholder qua the company, on reduction of capital by reduction of face value of shares of the company. It noted the observations of the Supreme Court to the effect that when, as a result of reducing the face value of the shares, the share capital is reduced, the right of the preference shareholder to the dividend or his share capital and the right to share in the distribution of the net assets upon liquidation is extinguished proportionately to the extent of reduction in the capital. According to the Supreme Court, such reduction of right of the capital asset amounted to a transfer within the meaning of that expression in section 2(47).

Further referring to the decision of the Karnataka High Court in the case of BPL Sanyo Finance Ltd(supra) and the decision of the Supreme Court in the case of Grace Collis(supra), the Tribunal concluded that if the right of the assessee in the capital assets stood extinguished either upon amalgamation or by reduction of shares, it amounted to transfer of shares within the meaning of section 2, and therefore computation of capital gains had to be made. As per the Tribunal, there could be no quarrel that reduction of equity shares under a Scheme of Arrangement and Restructuring in terms of section 100 of the Companies Act amounted to extinguishment of rights in the shares, and hence was a transfer within the ambit and scope of section 2 (47).

As regards cost of acquisition, the Tribunal referred to the Supreme Court decision in the case of D P Sandhu Brothers ChemburPvt Ltd (supra), where the court analysed its decision in B C Srinivasa Setty(supra), and concluded that an asset which was capable of acquisition act at a cost would be included within the provisions pertaining to the head “capital gains”, as opposed to assets in the acquisition of which no cost at all can be conceived. According to the Tribunal, from a plain reading of this judgement, the sequitur was, where the cost of acquisition is inherently capable of being determined or not, i.e. whether it was possible to envisage the cost of an asset which was capable of acquisition at a cost. The distinction had been made by the Supreme Court where the asset which was capable of acquisition at a cost would be included for the purpose of computing capital gains, as opposed to assets in the acquisition of which no cost at all could be conceived. If cost could be conceived, then it was chargeable under the head capital gains.

Applying this ratio to the facts before it, the Tribunal noted that the assessee had incurred the cost for acquiring the shares, and therefore there was no dispute regarding cost of acquisition. The assessee did not receive any consideration due to reduction of capital, which had resulted into a loss to the assessee. The issue examined by the Tribunal was, whether the price could be conceived or not? It noted that the price on paper for which the assessee had acquired the asset had been reduced to half the cost, as half the cost was waived off / extinguished.

The Tribunal raise the question that if Re 1 per share had been received on reduction of capital, could it be said that there was no consideration received or consideration was inconceivable, and if zero was received, could it be said that there was no conceivable consideration at all or that zero was not a consideration?

The Tribunal noted that this issue has been addressed by the Gujarat High Court in the case of Jaykrishna Harivallabhdas (supra), where the Gujarat High Court pointed out the incongruity, anamoly and absurdity of taking a view that in a case where a negligible or insignificant sum was disbursed on liquidation, capital gains was to be computed, but where nothing was disbursed on liquidation of the company, the extinguishment of rights would result in total loss with no consequence. The Gujarat High Court had accordingly held that even when there was a nil receipt of capital, the entire extinguishment of rights had to be written off as a loss resulting from computation of capital gains. According to the Tribunal, this ratio of the Gujarat High Court was clearly applicable on the facts of the case before it, because they could be no distinction where an assessee received negligible point insignificant consideration, and where the assessee received nil consideration. The Tribunal was of the view that this judgement and the ratio clearly clinched the issue in favour of the assessee.

The Tribunal therefore held that:

1.  the reduction of capital was extinguishment of right on the shares amounting to a transfer within the meaning and scope of section 2(47);
2.  the loss on reduction of shares was a capital loss and not a notional loss;
3.  even when the assessee had not received any consideration on reduction of capital but its investment was reduced to a loss, resulting into a capital loss, while computing the capital gain, capital loss had to be allowed or set-off against any other capital gain.

The Tribunal distinguished the decision of the Special Bench in the case of Bennett Coleman & Co(supra) by observing that that was a case of substitution of shares, which was not the case before it. The distinction on the facts had been noted by the Tribunal in the case of Care stream Health Inc.(supra). It noted the minority judgment in the Special Bench decision, where the accountant member had held that a shareholder who is capital has been reduced is deprived of his right to receive that part of the share capital which has been reduced and therefore it is an actual loss. In that minority judgement, the distinction between cases where cost of acquisition is incapable of ascertainment and cases in which it is ascertained as zero was clearly brought out.

The Tribunal observed that it was not relying upon the minority judgment in the Special Bench case, but that the case before it was of the revision under section 263. According to the Tribunal, the dissenting judgement when to show that it was a possible view, if a view had been taken by the AO in favour of the assessee, then the order of the AO could not be said to be erroneous and could not therefore have been set aside or cancelled. It noted that it was following the Gujarat High Court decision in the case of Jaykrishna Harivallabhdas(supra) as against the majority judgment given by the Tribunal Special Bench in Bennett Coleman & Co(supra).

The Tribunal therefore held that the AO had rightly allowed the computation of long-term capital loss, to be set-off against the capital gain shown by the assessee, and therefore set aside the revision order of the PCITu/s 263.

OBSERVATIONS

The heart of the controversy in this case revolved around the understanding of the Supreme Court decision in the case of B C Srinivasa Setty (supra) – whether the ratio decided applied to all situations where there was no cost of acquisition or whether it applied only to situations where the cost of acquisition was not conceivable. The language of the Court was “What is contemplated is an asset in the acquisition of which it is possible to envisage a cost. The intent goes to the nature and character of the asset, that it is an asset which possesses the inherent quality of being available on the expenditure of money to a person seeking to acquire it. It is immaterial that although the asset belongs to such a class it may, on the facts of a certain case, be acquired without the payment of money….”

This aspect has been analysed by the Supreme Court in the case of D P Sandhu Brothers ChemburPvt Ltd(supra) where the Supreme Court observed:

“In other words, an asset which is capable of acquisition at a cost would be included within the provisions pertaining to the head ‘capital gains’ as opposed to assets in the acquisition of which no cost at all can be conceived. The principle propounded in B.C. SrinivasaSetty’s case (supra) has been followed by several High Courts with reference to the consideration received on surrender of tenancy rights. [See Among others Bawa Shiv Charan Singh v. CIT [1984] 149 ITR 29 (Delhi); CIT v. MangtuRam Jaipuria [1991] 192 ITR 533 (Cal.); CIT v. Joy Ice Cream (Bang.) (P.) Ltd. [1993] 201 ITR 894 (Kar.); CIT v. MarkapakulaAgamma [1987] 165 ITR 386 (A.P.); CIT v. Merchandisers (P.) Ltd. [1990] 182 ITR 107 (Ker.)]. In all these decisions the several High Courts held that if the cost of acquisition of tenancy rights cannot be determined, the consideration received by reason of surrender of such tenancy rights could not be subjected to capital gain tax.”

It is therefore clear that as per the Supreme Court, capital gains is not capable of being computed only in a case where the cost of acquisition (or consideration as in this case) is not conceivable at all, and not in a case where it is conceivable, but is nil.

Though the decision of the Gujarat High Court in the case of Jaykrishna Harivallabhdas(supra) had been cited before the Special bench in Bennett Coleman’s case, it was not taken into consideration. This decision rightly brings out the absurdity of taking a view that one has to compute capital gains when there is a nominal consideration, and that one cannot compute capital gains when nothing is received. As observed by the Gujarat High Court:

“The contention that this provision should apply to actual receipts only also cannot be accepted for yet another reason, because acceptance of that would lead to an incongruous and anomalous result as will be seen presently. The acceptance of this view would mean whereas even in a case where a sum is received, howsoever negligible or insignificant it may be, it would result in the computation of capital gains or loss, as the case may be, but in a case where nothing is disbursed on liquidation of a company the extinction of rights, would result in total loss with no consequence. That is to say on receipt of some cost, however insignificant it may be, the entire gamut of computing capital gains for the purpose of computing under the head “Capital gains” is to be gone into, computing income under the head “Capital gains”, and loss will be treated under the provisions of Act, but where there is nil receipt of the capital, the entire extinguishment of rights has to be written off, without treating under the Act as a loss resulting from computation of capital gains. The suggested interpretation leads to such incongruous result and ought to be avoided, if it does not militate in any manner against object of the provision and unless it is not reasonably possible to reach that conclusion. As discussed above, once a conclusion is reached that extinguishment of rights in shares on liquidation of a company is deemed to be transfer for operation of section 46(2) read with section 48, it is reasonable to carry that legal fiction to its logical conclusion to make it applicable in all cases of extinguishment of such rights, whether as a result of some receipt or nil receipt, so as to treat the subjects without discrimination. Where there does not appear to be ground for such different treatment the Legislature cannot be presumed to have made deeming provision to bring about such anomalous result.”

Had this reasoning of the Gujarat High Court pointing out the absurdity been considered by the Special Bench in the case of Bennett Coleman(supra), perhaps the conclusion reached might have been different.

Therefore, the view taken by the Tribunal in the case of Tata Sons, that even in a case where nil consideration is received on reduction of capital, the capital loss is to be allowed, seems to be the better view of the matter.