This Tax Alert summarizes a recent ruling of the Delhi Income-tax Appellate Tribunal (Tribunal) in case of Seaview Developers Pvt. Ltd. (Taxpayer) v DCIT[1] on the issue of characterization of a court-approved reduction of share capital undertaken by an unlisted company. The key issue before the Tribunal was whether a reduction of share capital implemented pursuant to a scheme sanctioned by the Bombay High Court could be recharacterized as a buy-back of shares and subjected to the buy-back tax regime which trigger levy in the hands of the company while the income in the hands of shareholders is exempt.
The tax authority had held that the transaction, though structured as a reduction of capital, effectively resulted in extinguishment of shares and distribution of funds to the shareholder and was therefore triggering buy-back tax.
The Tribunal ruled in favor of the Taxpayer and held that reduction of share capital and buy-back are distinct corporate law mechanisms operating in separate statutory fields and cannot be treated as interchangeable merely because they may result in similar economic outcomes. The Tribunal observed that a capital reduction undertaken under a court-sanctioned scheme does not amount to a purchase of shares by the company and, therefore, cannot be recharacterized as a buy-back in the absence of a specific statutory provision. The Tribunal also noted that the legislative framework has historically maintained separate tax treatment for reduction of capital and buy-back transactions. Tribunal also held that where transaction of capital reduction is subjected to dividend distribution tax (DDT) as well as capital reduction and again subjecting the transaction to buy-back tax results in double taxation.
The Tribunal also allowed deduction of interest on borrowings used for capital reduction, holding that rationalization of capital structure constitutes a measure of commercial expediency undertaken for business purposes
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