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Reduction of Capital
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This is the brief note regarding reduction of share capital to be used as a way of
paying back the shareholders. In case of Foreign direct investment the companies
look for the way of taking the capital invested in India back to the home country. One
of the options available to the company is to reduce the share capital of Indian
company and paying the shareholders. In this note we have analyzed and discussed
the provisions of laws applicable in India to reduction of capital.
1. INTRODUCTION
The need of reducing capital may arise in various circumstances, for example, accumulated
business losses, assets of reduced or doubtful value, etc. As a result, the original capital may either
have become lost or a company may find that it has more resources that it can profitably employ.
In either of these cases, the need may arise to adjust the relation between capital and assets.
2. REDUCTION OF CAPITAL
Reduction of Capital is governed by Section 100 of the companies Act, 1956. It means reduction of
issued, subscribed and paid-up capital of the company. Reduction of share capital may be effected
in the following ways:
1. In respect of share capital not paid-up, extinguishing or reducing the liability on any of its
shares.
2. Cancel any paid-up share capital, which is lost, or is not represented by available assets.
This may be done either with or without extinguishing or reducing liability on any of its
Shares
3. Pay off the paid-up share capital, which is in excess of the needs of the company. This may
be achieved either with or without extinguishing or reducing liability on any of its shares.
All the above including repayment of capital requires prior sanction of Court. In
other words, there can be no retrospective approval for reduction of share capital.
3. IMPLICATIONS UNDER COMPANIES ACT
3.1 Power of the company for reduction of share capital
For a company to reduce its share capital, it should have the power under its Articles of Association
to do so. [Section 100]
3.2 Modes of reduction of share capital
The Act does not prescribe the manner in which the reduction of capital is to be effected nor is
there any limitation of the power of the Court to confirm the reduction except that it must be first
be satisfied that all creditors entitled to object to the reduction have either consented to the said
reduction or that they should be paid off or their interest secured. (British and American Trustee
and Finance Corp. vs. Couper (1894) AC 399)
Reduction of capital in the following ways is permissible under the Act:

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1. Diminishing the nominal amount of the share so as to leave a less sum unpaid;
2. Diminishing the nominal amount of any shares by writing off or repaying paid-up capital;
3. Diminishing the nominal amount by combining both (1) and (2);
4. Diminishing the number of shares by extinguishing the existing liability on certain shares,
writing off or repaying the whole amount paid-up thereon, and cancelling them.
4. PROCEDURAL ASPECTS AS PER COMPANIES ACT
4.1 Special Resolution
This is the first and main requirement for the reduction of share capital. Unless a special resolution,
as authorised by the articles, is passed for reduction of the share capital, a company cannot effect
share reduction.
4.2 Court Sanction
Next step for the Reduction of Share Capital is to secure the sanction of the Court for reduction.
Before confirming the reduction the Court shall be satisfied that the
• consent of the creditors to the reduction has been obtained or
• the creditors have been discharged or
• their debts or claims have been discharged or Special resolution and prior
settled or secured.
approval from court is required for
(The ‘creditor’ for this purpose means a person who has reduction of capital
a debt or any claim against the company of such a
nature as would have been provable in winding up.)
• As per section 102, the Court has first to be satisfied that the creditors who had objected to
the reduction that either their consent to the reduction has been obtained or their debts or
claims have been discharged or settled or secured.
• If the company does not admit or provide the full amount of debt or the amount is
contingent or not ascertainable then the Court has the right to fix the amount.
• Under the special circumstances and if the Court thinks it proper then it has the power to
dispense with the provisions of securing the debts of the creditors as mentioned above.
• In other cases the creditors can object only with the consent of the Tribunal.
4.3 Court confirming reduction and power on making such order
The Court may direct the company that the words "and reduced" be added to the Company’s name
for a specified period, and that the Company must publish the reasons for reduction of share capital
and also the causes which led to it, with a view to giving proper information to the public.
4.4 Registration & Minute of Reduction
• As per section 103(4) minutes with a copy of the order has to be registered with the
Registrar of the Companies and according to that Registrar of Companies will issue
Certificate under his hand or authenticated by his seal.

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• Once the minutes get registered it shall be deemed to be substituted for the corresponding
part of the memorandum of the company, and shall be valid and alterable as if had been
originally contained therein. The substitution of any such minute as aforesaid for part of the
memorandum of the company shall be deemed to be an alteration of the memorandum
within the meaning and for the purpose of section 40.
4.5 Liability of Members and Penalty
• On the reduction of share capital, the extent of liability of any past or present member on
any call or contribution shall not exceed the difference between the amount paid on the
share, or the reduced amount, if any, which is to be deemed to have been paid thereon, by
the member, and the amount of the shares fixed by the scheme of reduction.
• If, however any creditor entitled to object to the reduction of share capital is not entered in
the list of creditors by reason of his ignorance of the proceedings for reduction and after the
reduction, the company is unable to pay his debt or claim then every person who was
member at the time of the registration of the order and minutes of the reduction will be
liable to contribute for the payment of the debt of the creditor.
• If any officer of the company, who conceals the name of the creditor or misrepresents the
nature of the debt or claim of the creditor who is
entitled to object to the reduction of the share
capital as per the provisions of section 105.
6. IMPLICATIONS UNDER INCOME-TAX ACT, 1961 Reduction in share capital is
(‘IT ACT’) taxed as Dividend to the
When any company reduces the share capital as per the extent of accumulated profits
provisions of the Companies Act, 1956 by way of reducing
the face value of shares or by way of paying off part of
and distribution attributable
the share capital, it amounts to extinguishments of the to capital will be subject to
rights of the member to the extent of reduction of face
value of share capital and therefore it is treated as Capital Gain.
transfer under sec. 2(47) of the IT Act. The amount
received is liable to capital gain tax u/s. 45 of the IT Act.
There are two aspects involved in the taxability of the income received on reduction of capital in
the hands of the shareholders of the company
• Amounts distributed by the company on reduction of share capital to the shareholders
attributable to accumulated profits will be considered as deemed dividend u/s. 2(22)(d) and
will be chargeable accordingly, and,
• Distribution attributable to capital will be subject to capital gains tax u/s. 45.
Only the distribution, which is over and above the accumulated profits, can be treated as capital
receipts in the hands of shareholder and only when the capital receipt is in excess of original cost of
acquisition of that interest which stands extinguished, capital gains will arise to the shareholder.
This is supported by the following case laws:
• Kartikeya V. Sarabhai vs. CIT, 228 ITR 163 (SC),
It is held in this case that even if there is reduction in the face value of the shares and consequent
payment by the company to the shareholder towards such reduction, the transaction results in
extinguishments of right in the shares held by the shareholder. Consequently, the reduction of the
share capital would be eligible to capital gains. The Supreme Court has referred the decision in the
matter of Anarkali Sarabhai vs. CIT (SC), 224 ITR 422 in which case preference shares were

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redeemed in entirety whereas in the present case it was partly redeemed by reduction of share
capital, therefore the analogy is same.
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