SC dismisses SLP to hold that capital reduction leads to transfer of shares and exigible to capital gains taxation

This Tax Alert summarizes a ruling of the Supreme Court (SC) in the case of Jupiter Capital Pvt. Ltd. ^[1] (Taxpayer) which dismissed the petition filed by the Tax Authority against admissibility of capital loss arising in the hands of shareholders on cancellation of equity shares held in subsidiary company pursuant to a scheme of capital reduction. In other words, the issue under consideration was whether capital reduction by a company amounts to “transfer” under the Indian Tax Laws (ITL) in the hands of the Taxpayer-shareholder and, accordingly, whether the Taxpayer can claim capital loss, if any, pursuant to the same.

In facts of the case, the Taxpayer held 99.98% equity shares of an Indian Company (I Co). I Co undertook cancellation of equity shares held by the Taxpayer under a scheme of capital reduction in lieu of monetary consideration apart from cancelling lost capital due to losses. Accordingly, the Taxpayer’s holding in company was reduced from approximately 153.34 million shares to 9,998 shares with total post reduction shareholding remaining unchanged at 99.98%. The issue arose on admissibility of capital loss in the hands of Taxpayer on cancellation of such shares under provisions of the ITL. While the Tax Authority denied claim of capital loss in hands of the Taxpayer, the Bangalore Income-tax Appellate Tribunal (Tribunal) allowed the claim of capital loss. On appeal to Karnataka High Court (HC), the order of Tribunal was upheld.

The SC dismissed the special leave petition (SLP) filed by Tax Authority against HC’s order. Basis a series of settled judicial precedents, particularly, the ratio laid down by the SC in the case of Karthikeya V Sarabhai vs. CIT^[2] , it held that cancellation of equity shares by subsidiary company results in “transfer” under the provisions of the ITL as there is extinguishment of rights qua such shares. The SC held that capital loss arising on proportionate reduction in share capital of I Co is admissible even if the overall shareholding of the Taxpayer in I Co remains unchanged post reduction.