The Hindu Business Line : Transfer of capital asset

Will forfeiture of share capital in a company give rise to a capital loss recognisable under tax law? This is an issue which has been engaging the attention of investors.

Certain types of capital losses may not be considered for purposes of taxation.

T. C. A. Ramanujam

In CIT vs Grace Collis, the Supreme Court held that “the definition of ‘transfer’ in Section 2(47) of the Act is an ‘inclusive’ definition and, therefore, extends to events and transactions which may not otherwise be ‘transfer’ according to its ordinary, popular and natural sense.”

Investment decisions can lead to either capital gains or capital losses. Capital gains may be either long term or short term and will be considered for taxation on that basis.

Capital losses, on the other hand, are of two types. Certain types of capital losses may not be considered for purposes of taxation. You make an investment and the entity in which you invested is sunk. You lose the capital. Such a capital loss will never be considered for tax assessments.

On the other hand, you invest in shares and suffer a loss on realisation. That will give rise to capital loss and will have to be adjusted in framing the tax assessment. Will forfeiture of share capital in a company give rise to a capital loss recognisable under tax law? This is an issue which has been engaging the attention of investors.

When a person applies for allotment of shares in a company, he offers to take a certain number of shares or such a less number as may be allotted. The offer is accepted by the allotment either of the total number mentioned in the offer or a less number, to be taken by the person who made the offer.

According to company law jurists, acceptance of the offer and allotment constituted a binding contract to take that number of shares. An English court ruled that there is no magic whatsoever in the term ‘allotment’. An allotment is an appropriation, not of specific shares, but of a certain number of shares.
Karnataka HC Ruling

BPL Sanyo Finance Ltd, engaged in non-banking financial business, applied for allotment of one lakh equity shares of IDBI Ltd in response to a public issue of shares. IDBI allotted in all 89,200 shares. It appropriated share application money against the allotted shares and called upon BPL Sanyo to pay the balance of Rs 83,46,000 against the balance amount due on the shares.

Despite several notices by IDBI, BPL could not pay the outstanding allotment money. As per the terms of the public issue, non-payment of allotment money rendered the allotted shares and the money paid as the share application money liable for forfeiture. IDBI cancelled the allotment and forfeited the share application money of Rs 32.05 lakh deposited by BPL earlier towards share application money.

The resultant loss of Rs 32.05 lakh on account of forfeiture was claimed by BPL as short-term capital loss in the assessment year 1998-99. The claim was rejected by the assessing officer (AO).

The argument for disallowance was that the shares in question were not allotted to the company. A mere allotment letter only indicated that balance amount was to be paid to enable allotment of shares.

BPL did not get any right to IDBI shares. There was no transfer involved consequent to the forfeiture of share application money in terms of Section 2(47) read with Section 45 of the Income-Tax Act, 1961. The Tribunal having allowed the short-term capital loss, the Revenue took up the matter in appeal before the Karnataka High Court.

The High Court expressed the view that there was a binding contract between BPL and IDBI. As soon as the allotment is made, BPL would be deemed to have acquired a right in such shares even if the call monies or the full value of the shares had not been paid.

In a case where only share application money is paid and the balance is yet to be paid on actual allotment of shares, the holder of such allotment would be recognised as a member of IDBI. It will not be correct to say that BPL acquired no right in such shares on account of its failure to deposit the balance amount for allotment of shares.
Extinguishment
Section 2(47) of the Act covers every possible transactions resulting in the destruction, annihilation, extinction, termination, cessation or cancellation, by satisfaction or otherwise of all or any of the bundle of rights whether qualitative or quantitative, which the assessee has in a capital asset whether or not such an asset is corporeal or incorporeal.
BPL defaulted in not paying the balance money. Its rights in the shares stood extinguished on forfeiture by IDBI. The loss suffered by BPL is within the scope and ambit of transfer. The rights stood extinguished. It was a short-term capital loss.
It is a moot point whether there was a transfer in this case. But BPL lost a capital asset. The High Court’s ruling raises interesting issues on the meaning of ‘transfer’.

(The author is a former Chief Commissioner of Income-Tax.)

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