The Interconnect

Capital Reduction - Regulatory & Tax Issues: Part 1

Ketan Dalal (Managing Partner, Katalyst Advisors LLP)
Jul 30, 2019


Reduction of share capital is often resorted to by companies for internal restructuring or altering their capital structure; it entails reduction of issued, subscribed and paid up share capital (either equity shares or preference shares or both) of a company. The following are the more likely situations of capital reduction:

·   Capital reduction with payout;

·   Capital reduction without payout; and

·   Selective capital reduction for a certain class of shares, with or without payout.

There could be various objectives of capital reduction, such as the following:

·  A company may have accumulated losses which are being funded by share capital and/or share premium and the balance sheet is “bloated” as a result of a large share capital/premium on the liability side and accumulated losses on the asset side; setting of the accumulated losses against share capital/reserves leads to “right sizing” the balance sheet.

·  There may be a certain section of shareholders who have agreed to relinquish their interest in the company and their capital needs to be cancelled; this often happens in the case of a family settlement where some family members agree that they will not be part of a company and other family members may do likewise in another company.  This could be with or without a payout.

·   A company may have surplus funds and it may want to refund the surplus funds to the shareholders by reducing capital, either by reducing the face value or by cancelling some shares.

There are complex corporate laws, accounting and tax issues in relation to capital reduction and this Interconnect is the subject matter of this article.


The relevant part of the provisions of section 66 of the Companies Act, 2013 are reproduced as under:

Reduction of Share Capital.

66. (1) Subject to confirmation by the Tribunal on an application by the company, a company limited by shares or limited by guarantee and having a share capital may, by a special resolution, reduce the share capital in any manner and in, particular, may—

(a) extinguish or reduce the liability on any of its shares in respect of the share capital not paid-up; or

(b) either with or without extinguishing or reducing liability on any of its shares—

(i) cancel any paid-up share capital which is lost or is unrepresented by available assets; or

(ii) pay off any paid-up share capital which is in excess of the wants of the company,

alter its memorandum by reducing the amount of its share capital and of its shares accordingly:

As would be seen from the above, Section 66 of the Companies Act, 2013, provides that, for a company to reduce its share capital, it should have the power under its Articles of Association (‘AOA’) to do so. If the AOA does not contain any provision for reduction of share capital, the AOA must first be altered so as to give it such a power. Thereafter, a special resolution for reducing share capital must be passed. Subsequently, the reduction effected by such special resolution must be confirmed by the National Company Law Tribunal (‘NCLT’).

Listed Company Related

In case of listed companies, the company proposing a capital reduction must file the necessary documents with the Stock Exchanges for the approval of the Stock Exchanges as well as SEBI as provided under Regulation 37 of SEBI (LODR) Regulation, 2015, r.w. SEBI circular no. CFD/DIL3/CIR/2017/21 of March 10, 2017. The relevant provisions of Regulation 37 of SEBI (LODR) Regulation, 2015, are reproduced below:

37. (1) ………. the listed entity desirous of undertaking a scheme of arrangement or involved in a scheme of arrangement, shall file the draft scheme of arrangement, proposed to be filed before any ………. Tribunal under Sections 230-234 and Section 66 of Companies Act, 2013, whichever applicable, ………. with the stock exchange(s) for obtaining Observation Letter or No-objection letter, before filing such scheme with any ………. Tribunal, in terms of requirements specified by the Board or stock exchange(s) from time to time.”

In the context of a scheme involving capital reduction, once the approval is received from the Stock Exchanges and SEBI, the Scheme for reduction of share capital can be filed with the NCLT. The NCLT is required to serve notices to the Regional Director, Registrar of Companies and to SEBI for obtaining an NOC. Notices will also have to be given to all the creditors of the company. In case no remarks/ objections are received within a period of 3 months, it will be presumed that they have no objection to the reduction of capital.

As per Section 114 of Companies Act 2013, a resolution shall be a Special Resolution when the votes cast in favour of the resolution are not less than three times the number of the votes cast against the resolution by members so entitled and voting. While calculating this voting, both the promoter voting and minority voting is considered. As per the Companies (Management and Administration) Rules, 2014, in case of unlisted companies, the voting can happen either on show of hands, or by electronic means or on a poll or by postal ballot. However, in case of a scheme of capital reduction is undertaken by a listed company, an e-voting option has to be mandatorily provided to the shareholders as provided under Para I(A)(9)(a) of Annexure 1 of SEBI circular no. CFD/DIL3/CIR/2017/21 of March 10, 2017.

Selective Capital Reduction

A selective capital reduction differentiates between shareholders of the same class by resulting in compulsory extinguishment of capital of some shareholders, while leaving the other shareholders untouched. As mentioned above, the NCLT needs to approve the capital reduction scheme and logically, if shareholders agree and there is no detriment to creditors and if they approve, the NCLT should approve the scheme. It may be noted that the provisions of section 66 of the Companies Act, 2013, are very wide and the 2 clauses in section 66(b) of the Companies Act, 2013 are illustrative and not exhaustive. Having said this, there are different considerations when the company is either listed or has external minority shareholders vis-à-vis a closely held company.

Judicial precedents regarding public limited companies

In relation to public limited companies (especially those which were earlier listed and then got delisted) there are several judicial precedents, especially under the earlier regime where capital reduction schemes were required to be sanctioned by the High Court.  Some of these are as follows:

1.  One of the first landmark case in relation to selective capital reduction was in the case of Reckitt Benckiser (India) Ltd.[1], wherein the Delhi High Court held that the question of reduction of share capital should be treated as an internal issue of the company. In this given case, after a series of open offers, Reckitt Benckiser (India) Limited (‘RBIL’) was delisted and a reduction was proposed to return capital to all the remaining public shareholders (who continued to hold shares in RBIL). The reduction was objected to by a shareholder group on the grounds that there was no necessity to reduce capital and the reduction was discriminatory as it would extinguish the class of public shareholders. Ultimately, RBIL offered to let the objectors remain as shareholders and consequently, the Delhi High Court approved the capital reduction. However, the court laid down principles in relation to capital reductions and held that if there is a ploy to oust inconvenient shareholders in a scheme for reduction of share capital, the Court can treat the same in a particular case, as unfair and inequitable and reject the proposed reduction. Further, it was held that if the requisite majority of the shareholders of the company have approved the scheme of reduction of share capital, then the court (i.e. NCLT) only needs to exercise its discretion to determine whether the scheme of reduction is fair and equitable to all concerned shareholders.

2.  In relation to the requirement of special resolution by the shareholders for approving a capital reduction, the Bombay High Court in the case of Sandvik Asia Limited vs Bharat Kumar Padamsi[2] placed importance on such approval having been obtained from a majority of the minority (“MoM”) shareholders. It was observed that once it is established that non-promoter shareholders are being paid fair value of their shares and even majority of the non-promoter’s shareholders having voted in favour of the resolution shows that the court will not be justified in withholding its sanction to the resolution.

3.  In a case involving capital reduction of public shareholders post which delisting was envisaged, the Bombay High Court in the case of Cadbury India Limited[3], weighed the importance on the approval of a majority of the non-controlling shareholders and observed “the court will take into account, but not be bound by, the views of the majority.” Further, it was held that the court “will see what the views are of most of the non-promoter (minority) shareholders at the meeting. If the bulk of them have voted in favour, the court will not lightly disregard this expression of an informed view, one that lies in the domain of corporate strategy and commercial wisdom…”.  The Court was dealing with the third and final buy back offer and the context was a valuation issue; an overwhelming majority of the non promoter shareholders had also voted in favour of the resolution and that aspect weighed heavily with the Court and the court also mentioned that the commercial wisdom of the parties to the scheme, who have taken an informed decision, has to be kept in view by the Court.

The key takeaway is that where majority of shareholders are in favour of the reduction and where the value to be paid seems fair, the scheme ought to be sanctioned.

Judicial precedents in the NCLT regime

There have been certain judicial precedents in the NCLT regime, particularly for closely held companies and some of these are as follows:

1. In the decision of ARI Consolidated Investments Private Limited[4], the Mumbai Bench of NCLT has approved capital reduction of only non-promoter shareholders on repayment of capital to them. It seems that the NCLT view is that reduction of share capital without pay-out is not permitted, although no explicit provision restricting the same is mentioned under section 66 of the Companies Act, 2013.

2. The Mumbai bench of NCLT in the case of Ansa Decoglass Private Limited[5] rejected the petition for reduction of share capital. In the given case, 75% of the shareholding was sought to be cancelled without any pay-out of consideration. The shareholders whose 75% shareholding was sought to be cancelled also approved the said reduction of share capital (what was intended in this case was that shareholders holding 75% of the share capital had agreed to the reduction without any payment, even though the reserves and surplus was approximately 12 cr).  The said petition was rejected as the it was found that “With these strong fundamentals of the company, it is strange that the majority of the shareholders are not being paid off / returned any consideration at the time of reduction of share capital in the present petition”. The said petition seems to be in compliance with the conditions set out under section 66 of the Companies Act, 2013, and the NCLT decision does not seem to be consistent with the provisions of the Companies Act, 2013 since all the necessary conditions set out were complied with.

The key takeaway is that the NCLT is using its discretion to reject certain capital reduction petitions even in cases where shareholders whose shareholding is sought to be cancelled have voted in favour of the petition and also the necessary conditions and procedures set out under the Companies Act, 2013 have been complied with. Ideally, in such cases, the NCLT should permit the capital reduction since it is a company and shareholder matter (and is approved by a special resolution) and particularly in light of the wide ambit of section 66 of the Companies Act, 2013 as explained above.

(This article has been co-authored by Aseeim Agarwal)

[1] 122 DLT 612 dated 31st May 2005

[2] Appeal No. 308 of 2004 in Company Petition No. 478 of 2003 in Company Application No. 290 of 2003, decided on April 4, 2009

[3] Company Petition No. 1072 of 2009

[4] C.P. 1501/66/MB/2018 dated January 7, 2019

[5] C.P. 79/66/MB/2018 dated February 4, 2019

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