NCLT-cancelled shares hit capital loss claims

Mumbai: Cancellation of shares pursuant to an order by the National Company Law Tribunal (NCLT) is no longer a rarity. In certain instances, the tribunal calls for a share reduction in insolvency matters.
On cancellation, the shares become null and void and have no value. But, owing to lack of specific provisions in the Income Tax (I-T) Act, shareholders face challenges when it comes to claiming a capital loss in such instances.
A long-term capital loss arises if the listed shares are held for more than 12 months (unlisted shares require a holding period of 24 months). Long-term capital losses can be set off only against long-term capital gains. Short-term capital losses can be set-off against both short-term and long-term gains. Any unutilised capital loss can be further carried forward up to next eight years and be utilised as explained earlier. To carry forward the losses, it is vital the I-T return has been filed on time. Set-off of capital loss — or carry forward and set-off in subsequent year — means taxable capital gain gets reduced. This, in turn, reduces the income tax outgo.
Parag Ved, president of The Chamber of Tax Consultants (CTC), explains, “On cancellation, commercially shareholders have lost their money on account of failure of the company. Cancellation also amounts to extinguishment of rights in such shares, which is included in the definition of a transfer under section 2(47) of the I-T Act. Therefore, shareholders should be entitled to claim capital loss on cancellation of shares pursuant to an NCLT order.” The same scenario also plays out for security holders in case of a reconstruction scheme approved by the Reserve Bank of India, he adds.
Courts have taken a divergent view on the interpretation of section 48, which deals with computation of capital gains. This makes any claims by investors for capital loss arising on cancellation prone to litigation. CTC has raised this issue, as well as the need for clarity on capital reduction of shares, in their pre-Budget representation and meeting with CBDT officials.
“Under section 2(22)(d), any distribution made to shareholders pursuant to a capital reduction is taxed as dividend, to the extent of accumulated profits. The provisions are silent on the treatment of taxation of the amount distributed in excess of accumulated profits — whether it should be treated as capital gains, and on the manner of its computation. The Budget must clarify this issue,” says Ved.