The methodology of decreasing equity holders through the cancellation of shares or the repurchase of shares is commonly called as reduction of share capital. This is also a restructuring strategy under which a company restructures its capital strategically and reduces its capital to improve its financial health and shows the true and fair value of the company.

As per the Companies act 2013, under Section 66, the provisions of reduction of capital are stated according to which a company may reduce its capital as per the provisions stated in it.

Benefits of reduction:

  1. Restructuring of financial
  • Helps in eliminating accumulated losses or fictitious assets, presenting a true and fair view of the company’s financial health.
  1. Improvise financial ratios
  • Reducing share capital improves important financial ratios such as:
  • Debt-to-Equity Ratio: Lower equity leads to a more balanced ratio.
  • Return on Equity (ROE): Increases as the denominator (equity) decreases.
  • This improved financial standing boosts investor and stakeholder confidence.
  1. Enhance Market Perception
  • A restructured capital base signals to the market that the company has proactively addressed past losses or inefficiencies.
  • Enhances the company’s image and makes it more attractive to potential investors and creditors.
  1. Strengthen the dividend pay-out
  • With accumulated losses written off, companies can resume dividend payments to shareholders, which may have been prohibited earlier due to insufficient profits.
  1. Optimizing the capital Structure
  • It helps in aligning the capital structure with business requirements, especially when the paid-up capital is more than what the business requires.
  • Unproductive or excess capital is reduced, resulting in a leaner and more efficient capital base.
  1. Flexibility for Future Fundraising
  • Once the balance sheet is cleaned up, it becomes easier for the company to raise fresh capital from investors or through loans
  1. Safeguarding Minority Shareholders
  • Reduction of capital is generally carried out with due process and NCLT approval, ensuring that the interests of minority shareholders are protected.

Reasoning for capital restructuring:

  1. Adjudging accumulated losses:
  • To write off past accumulated losses or fictitious assets, thereby presenting a true and fair view of the financial position.
  • This helps the company resume dividend payments and boosts investor confidence.
  1. Increasing Earning per share:
  • Reducing the number of shares can increase the EPS, making the company's financial performance appear more favourable to investors
  1. May be due to business restructuring:
  • Decision of reduction may be taken due to restructuring of business due to merger and acquisition, amalgamation.
  1. Eliminating Capital errors
  • To correct errors made during the issue or allotment of shares, such as issuing shares at a premium but recording them incorrectly.

Procedure of reduction of capital

  1. Convene a board meeting:

The first step in the process of reducing share capital is to pass a resolution at a board meeting. This meeting must be convened by sending a notice at least seven days in advance, accompanied by an explanatory statement and the agenda covering the points to be discussed.

If the company is a listed entity, prior intimation as specified under Regulation 29 of the SEBI (LODR) Regulations, 2015, must also be sent to the stock exchanges.

  1. Convene general meeting:

Next, convene a general meeting and pass a Special Resolution approving the reduction of share capital by the members of the company. Within 30 days of passing the Special Resolution, file e-form MGT-14 with the Registrar of Companies (ROC), along with the board resolution, minutes of the board meeting and general meeting, and the proposal for the reduction of share capital.

  1. Application to tribunal for reduction of capital

An application for the reduction of share capital must be submitted to the National Company Law Tribunal (NCLT) to seek approval for the process. The application should be in the format specified by the NCLT in Form RSC-1 and accompanied by the prescribed fees as per the Schedule of Fees.

The application must include the following attachments:

  1. A list of creditors certified by the Managing Director (MD), or by two directors if the MD is absent, not older than 15 days from the date of filing the application. 
  2. A certificate from the auditor. 
  3. A declaration by the directors regarding the repayment of dues and any unpaid interest up to the date of filing.

  1. Notice or any direction received from the Tribunal

Within 15 days of filing the application, the Tribunal may issue a notice or give directions for representations, if any, from the Central Government, the company’s creditors, SEBI (in the case of a listed entity), or other relevant authorities.

The details regarding the representations sought and the directions issued must be published in a newspaper, accompanied by an affidavit in Form RSC-5, confirming the dispatch of the notice and its publication.

  1. Representation sent to creditors, ROC, RD/OL

The NCLT also sends a notice to the creditors within seven days, inviting their representations and any objections regarding the reduction of share capital process.

  1. NCLT order after filing the representation, objection:

The Registrar, SEBI, and creditors have a period of three months from the date of receiving the notice to file any representation or objection. If no reply is received within this period, it is presumed that there is no objection.

After considering the application, representations (if any), and the facts of the case, the NCLT, being satisfied with the fairness of the reduction of share capital process, grants approval in Form RSC-6.

  1. Filing the order of NCLT with ROC:

The company must deliver a certified copy of the Tribunal’s order, along with the minutes, to the Registrar of Companies (ROC) within 30 days. The submission should include details such as the amount of share capital reduced, the number of shares, and the amount of each share.

The ROC will then register the order and issue a certificate confirming the reduction of share capital in Form RSC-7.

  1. Other requirements:

After receiving approval for the reduction of share capital, the company must comply with the necessary provisions, including:

  • Alteration of the Memorandum of Association (MoA) and Articles of Association (AoA) to reflect the reduced share capital. 
  • Implementation of the approved scheme as per SEBI requirements (in the case of a listed entity).

Apart from the above-specified process of reduction of share capital, there are certain modes where NCLT approval is not required: 

  1. Forfeiture of Shares: When shares are forfeited due to non-payment of call money. 
  2. Buy-Back of Securities: When a company buys back its own securities under Section 68 of the Companies Act, 2013. 
  3. Redemption of Preference Shares: When redeemable preference shares are redeemed in accordance with the provisions of Section 55 of the Companies Act, 2013.

Tax implication:

Capital Gains Tax Implications on Reduction of Share Capital

  1. In the Hands of Shareholders:

When a company reduces its share capital, the impact on shareholders arises if the amount received exceeds the accumulated profits. The implications are as follows:

  • Capital Asset Treatment: Shares are treated as a capital asset as per Section 2(14) of the Income Tax Act. 
  • Transfer of Shares: Reduction of share capital leads to the extinguishment of shareholder rights, which amounts to a "transfer" as per Section 2(47) of the Act. 
  • Capital Gains Calculation: 
    • Capital Gains = Consideration received - Cost of acquisition of shares
    • If the consideration received is more than the accumulated profits, the excess amount is treated as capital gains. 
    • The nature of the capital gains (long-term or short-term) depends on the period of holding of the shares. 
    • Tax Rate:
  • Short-Term Capital Gains (STCG): Taxed at applicable slab rates. 
  • Long-Term Capital Gains (LTCG): Taxed at 20% with indexation (if listed, 10% without indexation if exceeding ₹1 lakh). 

In the Hands of the Company:

For the company, the tax implications are as follows:

  • Distribution of Accumulated Profits: If the reduction of share capital involves distributing accumulated profits, it is treated as dividend and taxed as Dividend Distribution Tax (DDT) under Section 115-O of the Income Tax Act (Note: DDT provisions were abolished from April 1, 2020, and dividends are now taxable in the hands of shareholders). 
  • Capital Reduction Accounting: Any reduction in share capital is adjusted against the Securities Premium Account or General Reserve. 
  • No Capital Gains for the Company: Reduction of share capital itself does not attract capital gains tax for the company, as it is not considered a transfer of capital assets.