KARTIKEY Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) WITH market rate of interest being in the neighbourhood of 15% a private limited company engaged in business, decided to reduce the face value of its 3% non cumulative preference shares from Rs. 1,000 to Rs. 50 (initially it was reduced to Rs. 500 and later on to only Rs. 50) and paid off Rs. 950 per share to its shareholders. This was done on the ground that the capital was in excess of the wants of the company. The assessee held 3% non redeemable preference shares in this private limited company which were purchased at Rs. 420 per share. Thus, the assessee got back Rs. 950 for the share purchased at Rs. 420. When the first reduction took place the assessee who had paid Rs. 420 had already got Rs. 500 and the share cost to him was Rs. 80 per share. On subsequent paying off of Rs. 450 by reducing the face value from Rs. 500 to Rs. 50, he got back Rs. 450 per share of which his cost was Rs. 80. Under these circumstances the question giving rise to this petition which is formulated in the next breath has arisen.

(2.) WHEN a company reduces its share capital by paying off a part of the paid up capital in exercise of powers under S. 100(1)(c) of the Companies Act, 1956 (and thus reduces its own liability vis a vis the shareholders) does it result in extinguishment of the right of the shareholders to the extent of the reduction of the face value of the share ? And the consequential question, if so, whether any profits or gains arising from such extinguishment are chargeable to income tax under the head 'capital gains' under S. 45 r/w S. 2(47) of the IT Act of 1961, the extinguishment being considered as a transfer within the meaning of the aforesaid provision, is the question which confronts us in this reference at the instance of the assessee. The Tribunal, Ahmedabad Bench 'C', having taken the view that income tax was chargeable under the head 'capital gains' under S. 4 in respect of all the profits or gains accruing to the assessee in the context of the aforesaid transaction pertaining to the asst. year 1967 68, the question has come up before us by way of the present reference under S. 256 of the IT Act.

(3.) WHEN the shareholder had no right to demand a refund of his share capital by insisting that it should extinguish or reduce its liability to the shareholders by doing so, how can it be contended that the payment was made to the shareholder in satisfaction of his right and not on account of the extinguishment of his right ? As discussed earlier, his right to dividend in the profits on the face value of Rs. 1,000 is partly extinguished as a result of the first reduction and he has a mere right to a dividend on the share capital of Rs. 500 though he no doubt continues to be a shareholder of the company. By the second reduction his right to receive a dividend from out of the profits on the share capital of Rs. 500 stands extinguished partly and his right is now restricted to claim a dividend on Rs. 50. Similarly, his right to share in the distribution on the footing of a share capital of Rs. 1,000 stands reduced upon the first reduction and by a further Rs. 450 by the second reduction. It is, therefore, clearly a case of extinguishment of his right. It is not as if in his capacity as the preference shareholder he stood in the position of a creditor vis a vis the company. He had no right to demand refund or reduction of capital by paying off a part of the capital. He did not have any such right. No such right is extinguished and no payment has been made on account of any such right or in lieu of such a right. It cannot, therefore, be said that the payment has been made in satisfaction of these rights. The payment has been made because his right in the shareholding in respect of preference shares which were of the face value of Rs. 1,000 originally was extinguished to the extent of Rs. 500 per share by the first reduction and to the extent of further Rs. 450 by the second reduction. The payment made to him is on account of the extinguishment of his right to the aforesaid extent and on no other account. Such being the position the basis of the reasoning in R.M. Amin's case (supra), is of no avail to the assessee. The Revenue seeks to reinforce its submission on this point by recourse to the reasoning which found favour with a Division Bench of this High Court in CIT vs. Minor Bababhai (1981) 128 ITR 1 (Guj) : TC20R.1108. The question arose in the context of the fact that the debt due to the assessee in that case under a promissory note held by him was scaled down by 55% by way of a scheme of compromise framed in the course of winding up proceedings instituted against a company. The assessee had to let off 55% of his claim with interest under the scheme and in consideration thereof he received 45% of the balance without interest by instalments and became entitled to equity shares of Rs. 50 each to the extent of 5% of his claim without interest. The Court took the view that it constituted a novation and the payment which was made to him, was in the context of the scheme and/or arrangement sanctioned by the Court, whereby he was paid 45% of the original amount without interest along with the equity shares, and was not in repayment of the original debt under the promissory note. The Court upheld the contention that the capital asset which originally belonged to the assessee no longer remained in existence. A new right had arisen in his favour by reason of the scheme. The old contractual rights between the parties got substituted by new rights which resulted in the extinguishment of the assessee's right in the erstwhile capital asset. On this reasoning the Court took the view that the assessee was entitled to claim a short term capital loss of Rs. 11,617 which represented the difference between the valuation of the original asset on the one hand and the payment that was received under the scheme on the other. The essence of the matter is that though there was a debtor creditor relationship initially the shortfall in the amount received under the scheme was considered as resulting in a capital loss on account of an extinguishment of the original right by reason of the substitution of the right under the promissory note by the right under the scheme. In the present case the Revenue is, therefore, justified in contending that to the extent that his original right before reduction was substituted by a new right, upon reduction, there was an extinguishment of his right in the shareholding. In a way, therefore, the decision in Minor Bababhai's case (supra), lends support to the view canvassed by the Revenue. The House of Lords in Scottish Insurance Corpn. Ltd. vs. Wilsons & Clyde Coal Co. Ltd. (1949) AC 462 : (1949) 1 All ER 1068, has referred to the consequence of a return of capital to the holder of preference shares as amounting to an "extinguishment". Therein, it is observed as under (see the speech of Lord Morton) :