by Capital Reduction is a corporate action taken to decrease a company’s share capital. It usually occurs when a company has accumulated significant losses or when assets are overvalued. By reducing capital, a company can restructure its financial statements to reflect its true position. It also helps in cleaning up the balance sheet, writing off fictitious assets, accumulated losses, and improving investor confidence.
Under Indian corporate law, particularly the Companies Act, 2013 (Section 66), capital reduction is permitted but subject to strict legal procedures and approvals.
Legal Procedures Involved in Capital Reduction:
1. Articles of Association Authorization
The company’s Articles of Association (AoA) must permit capital reduction. If not, they must be amended before proceeding.
2. Special Resolution
A special resolution must be passed in a general meeting by shareholders approving the capital reduction scheme. The resolution must describe the purpose and terms of the reduction.
3. Application to NCLT
The company must file a petition with the National Company Law Tribunal (NCLT) for approval. The petition should include:
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Certified copy of the special resolution
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Scheme of reduction
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Latest audited financial statements
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List of creditors
4. Notice to Stakeholders
Upon receiving the application, the NCLT orders the company to:
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Notify the Registrar of Companies (RoC)
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Inform the Securities and Exchange Board of India (SEBI) (for listed companies)
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Serve notices to creditors and shareholders
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Publish notice in newspapers (both vernacular and English)
5. Objections and Hearings
Creditors, shareholders, or regulatory bodies may file objections. NCLT conducts a hearing and ensures that the reduction does not adversely affect stakeholders.
6. NCLT Approval
If satisfied, the NCLT will confirm the reduction. The company must file the NCLT order with the RoC, after which the reduction becomes effective.
7. Compliance Filings
Post-approval, the company must:
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File Form INC-28 and Form MGT-14 with the RoC
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Make necessary changes in the capital clause of the Memorandum of Association
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Update statutory registers and financial statements
Accounting Treatment – Capital Reduction Account:
Capital reduction is accounted for by opening a Capital Reduction Account (sometimes also called Reconstruction Account). This is a temporary account used to adjust the balances resulting from the reduction scheme.
Common Adjustments through Capital Reduction Account:
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Writing off Accumulated Losses
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Eliminating Fictitious Assets (e.g., Preliminary expenses, goodwill, discounts on issue of shares)
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Revaluation of Assets and Liabilities
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Refund of excess paid-up capital
illustrative Journal Entries:
| S. No. | Transaction | Journal Entry |
|---|---|---|
| 1 | Reduction in face value of shares | Share Capital A/c Dr. To Capital Reduction A/c |
| 2 | Writing off accumulated losses | Capital Reduction A/c Dr. To Profit & Loss A/c (Debit Balance) |
| 3 | Writing off fictitious assets | Capital Reduction A/c Dr. To Goodwill/Preliminary Expenses A/c |
| 4 | Revaluation surplus or deficit adjustment | Asset A/c Dr. or Cr. To Capital Reduction A/c (or vice versa) |
| 5 | Transfer of balance in Capital Reduction A/c to Capital Reserve | Capital Reduction A/c Dr. To Capital Reserve A/c (if surplus remains) |
Reconstructed Balance Sheet
Key Changes in Reconstructed Balance Sheet:
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Share Capital reduced to revised amount
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Fictitious assets removed
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Accumulated losses written off
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Asset and liability values adjusted if revaluation is involved
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Creation of Capital Reserve (if applicable)
Example:
Before Capital Reduction
ABC Ltd. (Extract of Balance Sheet)
Liabilities:
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Share Capital: ₹10,00,000 (1,00,000 shares @ ₹10 each)
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Accumulated Losses: ₹4,00,000
Assets:
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Goodwill: ₹1,00,000
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Preliminary Expenses: ₹50,000
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Other Tangible Assets: ₹4,50,000
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Cash: ₹4,00,000
Capital Reduction Scheme
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Reduce face value of shares from ₹10 to ₹6 (capital reduced by ₹4/share)
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Write off goodwill, preliminary expenses, and accumulated losses
Journal Entries:
| S. No. | Transaction | Journal Entry |
|---|---|---|
| 1 | Share capital reduction | Share Capital A/c Dr. ₹4,00,000 To Capital Reduction A/c ₹4,00,000 |
| 2 | Write off goodwill | Capital Reduction A/c Dr. ₹1,00,000 To Goodwill A/c ₹1,00,000 |
| 3 | Write off preliminary expenses | Capital Reduction A/c Dr. ₹50,000 To Preliminary Expenses A/c ₹50,000 |
| 4 | Write off accumulated losses | Capital Reduction A/c Dr. ₹2,50,000 To Profit & Loss A/c ₹2,50,000 |
Reconstructed Balance Sheet of ABC Ltd.
Liabilities:
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Share Capital: ₹6,00,000 (1,00,000 shares @ ₹6 each)
Assets:
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Tangible Assets: ₹4,50,000
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Cash: ₹4,00,000
Note: Goodwill, preliminary expenses, and losses have been written off.
Compliance Requirements:
1. Filing with ROC
Post approval and execution, the NCLT order must be filed with the RoC to make the changes legally binding.
2. Updating Corporate Documents
The Memorandum and Articles of Association must reflect the new capital structure. Statutory registers (like Register of Members) must also be updated.
3. Disclosures in Financial Statements
As per Schedule III of the Companies Act, all changes due to capital reduction must be clearly disclosed in the financial statements, including:
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Nature of reduction
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Effects on profits and capital
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Legal compliance status
4. Board and Audit Committee Approval
The Board of Directors and Audit Committee must review and approve the restructured balance sheet, accounting entries, and financial disclosures.
Key Points to Remember:
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Capital Reduction must not prejudice creditor rights.
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It is a court-approved and closely regulated process.
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The Capital Reduction Account is a temporary account used only for internal adjustments.
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Reconstructed balance sheets must be accurate and show a true and fair view.
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Misuse or misstatement in capital reduction can lead to penalties or disqualification of directors.
