Objectives of Capital Reduction

14/10/2022 0 By indiafreenotes

Reduction of share capital is often resorted 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 most likely situations of capital reduction.

  1. Capital reduction without pay-out or
  2. Capital reduction with pay-out
  • To all the shareholders
  • To selective shareholders
  1. Returning surplus capital: A company may have capital which is surplus to its requirements for the foreseeable future and which it may therefore wish to return to its shareholders.
  2. Redeeming Shares: A company may wish to redeem its shares but it cannot do so if it has insufficient distributable reserves.
  3. Distributing non- cash assets: A company may also use a capital reduction to transfer non-cash assets that it owns to its shareholders, although this is relatively unusual.
  4. Structuring mergers and acquisitions as part of a scheme of arrangement: Capital reductions have become a popular method of structuring mergers and acquisitions or group restructurings.
  5. Demergers: Capital reduction can be used to split one company’s activities into different companies, called a demerger. Demergers are often used with the help of a scheme of arrangement.

Capital reduction with pay-out:

Advantages of capital reduction with payout for the company are:

  • Easy to distribute surplus cash to shareholders.
  • No limit for distribution like in buyback or dividend.
  • As a consideration, Company may give assets to the shareholders which were not allowed in the buyback.

The capital reduction is provided by section 66 of the companies act 2013 and its taxability is provided in various provisions of the Income Tax Act 1961. We shall discuss regulatory and taxation aspects in case of capital reduction of equity shares.

Capital Reduction: Provisions under the Companies Act 2013

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. Thereafter, a special resolution for reducing share capital must be passed by shareholders. Subsequently, the reduction effected by such special resolution must be confirmed by the National Company Law Tribunal (NCLT).

As generally understood, capital reduction is uniform for all the shareholders of the particular class. In this case, it can be compulsory for all the shareholders to abide by the order of the honourable NCLT confirming the special resolution of the shareholders for the size, amount and other terms of the reduction.