What is Capital Reduction?
Capital reduction is a corporate restructuring process that involves reducing the share capital of a company. This can be achieved through various methods such as canceling unpaid capital, repaying capital to shareholders, or writing off accumulated losses against share capital.
Key Aspects of Capital Reduction
- • Reduces the issued, subscribed, and paid-up share capital
- • Requires NCLT approval under Section 66 of Companies Act 2013
- • Creditor interests must be protected
- • Can be used to write off losses or return surplus capital
- • May or may not involve repayment to shareholders
- • Distinct from share buyback (which is governed by Section 68)
Reasons for Capital Reduction
Write Off Losses
Using capital reduction to write off accumulated losses and create a clean balance sheet for future operations.
Return Surplus Capital
Returning excess capital to shareholders when the company has more capital than required for operations.
Simplify Capital Structure
Canceling unissued or uncalled capital to streamline the capital structure.
Demerger/Restructuring
Part of larger corporate restructuring to reorganize capital base.
Methods of Capital Reduction
Method 1: Canceling Unpaid or Uncalled Capital
The company cancels the unpaid portion of share capital, releasing shareholders from the obligation to pay future calls. This does not involve any payment to shareholders.
Method 2: Reducing Nominal Value of Shares
The face value of shares is reduced (e.g., from ₹10 to ₹5 per share), and the excess may be returned to shareholders or used to write off losses.
Method 3: Paying Off Part of Paid-up Capital
The company returns a portion of the capital contributed by shareholders. This is often done when the company has surplus capital not required for business operations.
Method 4: Writing Off Accumulated Losses
The debit balance in Profit & Loss Account or other losses are written off by reducing the share capital. This is the most common reason for capital reduction.
Method 5: Combination Approach
Multiple methods can be combined, such as reducing capital to write off losses while simultaneously returning some capital to shareholders.
Legal Framework
Companies Act 2013 - Section 66
Section 66 provides the procedure for reduction of share capital:
- • Special resolution required for capital reduction
- • Application to NCLT for confirmation of reduction
- • Creditor protection mechanism
- • NCLT may order publication of notice
- • NCLT may require creditor consent or secure their interests
- • Filing of certified NCLT order with ROC
Section 68 - Buyback of Shares (Alternative)
Buyback is an alternative to capital reduction under Section 66. Key differences:
| Aspect | Section 66 (Capital Reduction) | Section 68 (Buyback) |
|---|---|---|
| Approval Required | NCLT confirmation | Board or shareholders only |
| Timeline | 3-6 months | 1-2 months |
| Creditor Process | Detailed creditor protection | Declaration of solvency |
| Methods | Any reduction method | Purchase from shareholders only |
SEBI Regulations (for Listed Companies)
- • SEBI (Buyback) Regulations 2018 for buybacks
- • SEBI (LODR) Regulations for capital reduction disclosure
- • Stock exchange approval may be required
- • Public announcement requirements
Capital Reduction Process
Step 1: Board Meeting
- • Approve concept of capital reduction
- • Appoint valuers and advisors
- • Fix date for general meeting
- • Approve draft notice and explanatory statement
Step 2: Valuation
- • Valuation by registered valuer (for listed companies)
- • Determine fair value of shares
- • Basis for return of capital (if applicable)
Step 3: General Meeting
- • Pass special resolution (75% majority)
- • Explanatory statement detailing reduction scheme
- • Voting by poll for listed companies
Step 4: NCLT Application
- • File petition in Form NCLT-1
- • Attach special resolution, notice, and valuation report
- • Proposed scheme of reduction
- • Affidavit verifying petition
Step 5: NCLT Directions
- • NCLT may order publication of notice
- • Notice to creditors (if required)
- • Notice to regulatory authorities
- • Objection period (typically 14-30 days)
Step 6: NCLT Hearing and Order
- • Hearing of objections (if any)
- • NCLT evaluates fairness and creditor protection
- • Order confirming reduction
- • May impose conditions
Step 7: Compliance and Filing
- • File certified copy of NCLT order with ROC
- • File Form INC-28 within 30 days
- • Amendment of MOA (share capital clause)• Issue amended share certificates (if face value changed)
NCLT Approval Process
Documents for NCLT Petition
- • Petition in Form NCLT-1
- • Company memorandum and articles
- • Copy of special resolution
- • Notice of EGM with explanatory statement
- • Scheme of capital reduction
- • Valuation report
- • Audited financial statements (last 3 years)
- • Affidavit verifying petition
- • Consent of creditors (if obtained)
- • Board report explaining rationale
NCLT Considerations
NCLT evaluates the following before confirming reduction:
- • Whether reduction is fair and equitable
- • Creditor interests are protected
- • No public interest is prejudiced
- • Proper disclosure has been made
- • Accounting treatment is proper
- • Compliance with Companies Act requirements
Creditor Protection
NCLT may require:
- • Consent of creditors
- • Securing payment of creditor claims
- • Setting aside funds for contingent liabilities
- • Bank guarantee for creditor protection
Buyback of Shares (Alternative)
Conditions for Buyback (Section 68)
- • Authorized by Articles of Association
- • Special resolution (for buyback >10% of capital)
- • Board resolution sufficient (for buyback up to 10%)
- • Debt-equity ratio not to exceed 2:1 after buyback
- • Only fully paid-up shares can be bought back
- • Buyback to be completed within 12 months
Sources of Buyback
- • Free reserves
- • Securities premium account
- • Proceeds of fresh issue (not for same kind of shares)
Buyback Process
Board approval and declaration of solvency
Shareholder approval (if required)
File Letter of Offer with ROC
Open escrow account
Dispatch offer to shareholders
Acceptance and payment
Cancel shares and file return
Creditor Protection
NCLT Requirements
Under Section 66, NCLT must ensure that creditor interests are not prejudiced by capital reduction. The following mechanisms are used:
Consent Method
Obtain written consent from all creditors or majority creditors representing a significant value.
Securing Method
Provide security for payment of creditor claims or set aside funds to meet creditor obligations.
Creditor Notice Period
NCLT typically orders:
- • Publication of notice in newspapers
- • Individual notice to known creditors
- • 14-30 day period for raising objections
- • Hearing of objections in court
Accounting Treatment
Writing Off Losses
Dr. Share Capital Account
Cr. Profit & Loss Account (for losses)
Cr. Capital Reserve (if any surplus)
Return of Capital
Dr. Share Capital Account
Cr. Bank Account (amount paid to shareholders)
Reduction of Face Value
Example: Reducing face value from ₹10 to ₹5 per share:
Dr. Share Capital Account (₹5 per share)
Cr. Capital Reserve / Bank Account
Tax Implications
For the Company
- • No tax on capital reduction itself
- • Writing off losses does not create taxable income
- • Buyback of shares taxed under Section 115QA (20% + surcharge + cess)
- • No deduction for amounts paid to shareholders
For Shareholders
| Scenario | Tax Treatment |
|---|---|
| Return of capital | Not taxable (reduces cost of acquisition) |
| Distribution from accumulated profits | Taxable as dividend income u/s 2(22)(d) |
| Buyback consideration | Exempt u/s 10(34A) (tax paid by company) |
| Cancellation without payment | Capital loss may be claimed |
Section 2(22)(d) - Deemed Dividend
If capital reduction involves distribution from accumulated profits (excluding capitalized profits), it may be treated as deemed dividend in the hands of shareholders.