Reduction of Share Capital – An Overview

• Meaning and Purpose: Reduction of share capital means the reduction of issued, subscribed and paid-up capital of the Company. The reduction of capital is mainly 
  done by companies for producing a more efficient capital structure.
• Power to alter the Capital: To reduce its share capital, the company should have the power under its Articles of Association to do so. If the Articles do not contain any provision for reduction of capital, the Articles must first be altered so as to give such power and then the special resolution for reducing capital must be passed.
• Reduction of Share Capital: Reduction may be effected in one of the following ways:

1. In respect of share capital not paid-up, extinguishing or reducing the liability on any of its shares. (For example, if the shares are of face value of INR 100 each of which INR 75 has been paid, the company may reduce them to INR 75 fully paid-up shares and thus relieve the shareholders from liability on the uncalled capital of INR 25 per share); or
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 (For example, if the shares of face value of INR 100 each fully paid-up is represented by INR 75 worth of assets. In such a case, reduction of share capital may be effected by cancelling INR 25 per share and writing off similar amount of assets); or
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. (For example, shares of face value of INR 100 each fully paid-up can be reduced to face value of INR 75 each by paying back INR 25 per share.)

• ALTERNATIVE : In the case of oppression and mismanagement, the Tribunal has been given powers under section 242 to pass an order as it thinks fit which may provide for purchase of shares of any members by the company and consequent reduction of the share capital.
• Taxability: The income received on capital reduction would be taxable as under:
• Amounts distributed by the company on capital reduction to the extent of its accumulated profits will be considered as deemed dividend under section 2(22)(d) and the company will have to pay dividend distribution tax on the same,
• Distribution over and above the accumulated profits, in excess of original cost of acquisition of shares would be chargeable to capital gains tax in the hands of the share holders.