The Supreme Court has reiterated the settled legal position that reduction of share capital leading to extinguishment of shareholder rights amounts to a “transfer” within the meaning of Section 2(47) of the Income Tax Act, 1961, thereby giving rise to taxable capital gains or allowable capital loss, as the case may be.

In the present case, the assessee, a company engaged in investment and financing activities, held an overwhelming majority shareholding in its subsidiary. Due to accumulated losses eroding the subsidiary’s net worth, a scheme for reduction of share capital was sanctioned by the High Court. Pursuant to such reduction, the number of shares held by the assessee was substantially reduced, while the face value of the shares remained unchanged. The assessee also received monetary consideration as part of the restructuring.

The Assessing Officer disallowed the long-term capital loss claimed by the assessee on the ground that the reduction in the number of shares did not constitute a transfer, as there was no change in the face value of shares or the percentage of shareholding. This view was affirmed by the Commissioner (Appeals). However, the Income Tax Appellate Tribunal allowed the assessee’s claim, holding that the reduction in share capital resulted in extinguishment of rights in respect of the reduced shares, squarely attracting Section 2(47).

The High Court upheld the Tribunal’s view, relying on the authoritative judgment of the Supreme Court in Kartikeya V. Sarabhai v. CIT, wherein it was held that extinguishment of any part of a shareholder’s rights, even without a conventional sale, constitutes a transfer for the purposes of capital gains taxation.

Affirming the High Court’s decision, the Supreme Court observed that Section 2(47) provides an inclusive definition of “transfer”, encompassing not only sale or exchange, but also relinquishment or extinguishment of rights in a capital asset. The Court clarified that it is not necessary for a shareholder to cease being a shareholder entirely for a transfer to occur. Any reduction in the bundle of rights attached to shares, whether quantitative or qualitative, would amount to an extinguishment of rights.

The Court further reiterated that reduction of share capital or redemption of shares is, in substance, a return of capital by the company and involves the company purchasing its own shares under statutory authority. Such transactions have consistently been held to constitute transfers under Section 2(47), as affirmed in Anarkali Sarabhai v. CIT and allied precedents.

It was thus held that the proportionate reduction in the assessee’s shareholding pursuant to the sanctioned scheme resulted in extinguishment of rights in respect of the reduced shares and consequently constituted a transfer.
The capital loss arising therefrom was therefore allowable under the Income Tax Act. The Special Leave Petition filed by the Revenue was accordingly dismissed.

 SOURCE LINK- https://api.sci.gov.in/supremecourt/2024/39934/39934_2024_15_15_58197_Judgement_02-Jan-2025.pdf

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