Forfeiture of share amount to extinguishment hence transfer, loss of payments made earlier is allowable

[C.A. DEV KUMAR KOTHARI]

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Section 45, 47 and 48 of Income-tax Act 1961

Dy. CIT v. BPL Sanyo Finance Ltd. [2009 -TMI - 33346 - KARNATAKA HIGH COURT]

CIT v. Mrs. Grace Collis [2008 -TMI - 5986 - SUPREME Court]

FORFEATURE OF SHARE AMOUNT TO EXTINGUISHMENT HENCE TRANSFER, LOSS OF PAYMENTS  MADE EARLIER IS ALLOWABLE . PER AUTHOR- IN SUCH CASES THERE IS ALSO TRANSFER OF RIGHTS IN SHARES.

By CA Dev Kumar Kothari

Forfeiture of shares:

Many times companies issue shares with condition that payment is to be made in two or more installments. The usual course is to collect money as share application money, allotment money, and one or more call money. Incase full payment is received at the time of application or in case of excess subscription  and application and lower allotment many times share application is adjusted against allotment money and call money and shares may be marked fully paid-up. In case of fully paid-up share there will be no question of forfeiture of share.

The shares may be differently paid according to the terms of issue and payments made by shareholder. For example, suppose a shareholder has paid application money @ Rs.2 per share another had paid application and allotment money of Rs.2+2= 4 per share and another had also made payment of all calls money of say Rs.6 per share so his share is fully paid-up. In these cases shares of Rs.2 Rs.4 and Rs.10 paid-up are held by these shareholders. They will have proportionate right of dividend, and voting (vide section 87(2) of the Companies Act, 1956.

Non-payment is breach of contract on part of share holder:

The terms of issue of shares may provide for payment in installments. In case of delay there can be contract to pay interest for period of delay. As per terms of issue, if the payment is not made in specified time, the issuer company can forfeit the money received as well as the shares allotted. Some times company may vary such terms and extend time for payment. This is adopted when the share price is not appreciated as expected or when share price has fallen.  

Non- payment of money due on share amount to breach of contract on part of the company, and therefore as per terms and conditions of issue after allowing prescribed time and opportunity, if the shareholder fails to pay the money due, the company can forfeit shares. Shares so forfeited no longer remain share of the shareholder, in hands of shareholder shares forfeited means that for him those shares have extinguished. He money paid by him is also not refundable by the company. Therefore, the money paid on such shares is a loss.

Business loss or loss under head capital gains:

In case the shares were held as stock-in-trade, the resultant loss will be business loss allowable under section 28. In case the shares were held as capital asset, then the loss will be on account of capital assets. Therefore, the loss will be allowable under the head 'capital gain', if the conditions for allowability of such loss are fulfilled.

Effect of forfeiture of share:

The company delete those shares from the register of shareholders holding in its register of members. The shareholders stake is reduced. The shareholders voting power is reduced as he has no voting power in respect of shares held earlier but not forfeited. For computation of loss under the head capital gains one of requirement is that the asset should be transferred.

The other legal effect of forfeiture is that the shares forfeited are described as forfeited shares by company. The company can reissue such shares to other persons in terms of the provisions of the Companies Act 1956 and the Articles of Association (AOA) of the company. Such reissue may result into premium collection or issue at a discount. Therefore, it can be said that in a practical manner the shares forfeited stand transferred to the company itself with a right to the company to re-issue such shares.

Commercial expediency in let shares be forfeited:

Sometimes the shareholder may find it commercially expedient to let the shares be forfeited. This happens when larger amount is payable in respect of partly paid shares and the market value has fallen. For example in case of Jindal Vijayanagar Steel Ltd, the company had issued shares of Rs.10 per share, withRs.2.50 paid on application/ and or allotment. Subsequently the price of even fully paid up share had fallen considerably. In such circumstances paying balance money was costlier than purchasing fully paid-up shares from market. Many investors had in such circumstances decided to let partly paid shares be forfeited. At that time we had seen quotation of shares of that company for fully paid-up shares and partly paid-up shares -paid up to different extent.

Extinguishment amount to transfer:

As discussed above, in case of forfeiture of shares, there is no extinguishment of share itself. The share in effective way stand transferred to the company with a right to reissue the same. However, so far share holder is considered, it can be said that his share is transferred for nil price received but with his obligation to pay for partly paid up shares being discharged. For example:

Issue face value Rs.10/-

Application and allotment money paid Rs.3/-

Balance payable Rs.7 plus interest for delay say rw.1/- total Rs.8/-.

The market price of fully paid up share is say Rs. 4/- per share. Therefore, shareholder let his shares be forfeited. He is discharged from obligation to pay Rs.8/- but his shares stands transferred (or say extinguished) for no money received. Therefore, in this case the amount paid @ Rs. 3/- per share is his loss.

 In case of trading activity, undoubtedly such loss is allowable as business loss. In case of share held as capital asset, the loss is allowable as loss under the head 'capital gains'.

Recent judgment of Karnataka High Court:  

In Dy. CIT v. BPL Sanyo Finance Ltd. [2009 -TMI - 33346 - KARNATAKA HIGH COURT] the case of loss on forfeiture of share arose. Tribunal had allowed the loss, the revenue had preferred an appeal under section 260A of the Income-tax act, 1961 with the following questions for opinion of the court:

"1. Whether, on the facts and circumstances of the case, the Tribunal was justified in holding that the loss on account of forfeiture of share application money of the assessee to the tune of Rs. 32,50,000 is a short-term capital loss for the assessment year 1998-99 ?"

2. Whether, on the facts and circumstances of the case, the Tribunal was justified in holding that the forfeited share application money of the assessee to the tune of Rs. 32,50,000 claimed by the assessee as short-term capital loss for the assessment year 1998-99 for obtaining the equity shares of IDBI Limited, is within the meaning of section 2(47) read with section 45 of the Income Tax Act, 1961 ?"

Facts of the case:

Assessee was engaged in non-banking financial business, etc.

Assessee had applied for allotment of one lakh equity shares of the IDBI Limited by paying the share application money of Rs. 32,50,000.

The IDBI Limited's issue was overscribed so it allotted in all 89,200 shares to the assessee as against one lakh equity shares applied for by it.

 Thereafter, the issuer  the IDBI Limited, after appropriating share application money, against their allotted shares of 89,200 called upon the assessee to pay the balance sum of Rs. 83,46,000 for issuance of shares in its favour.

The assessee did not pay the money called for in spite of notices issued by IDBI.

This resulted into forfeiture of share application money as per the terms of the issue.

- (Per author there must also be forfeiture of 89,200 shares allotted which were partly paid up and in respect of which allotted had right , by paying further sums shareholder can increase paid-up value). In many cases where capital is contributed over a period of time and in instalments, even partly paid-up shares, and partly paid-up shares to different extent are also separately quoted). With respect it seems that there is a mistake in recording of facts. Besides share application money, shares are also forfeited. In allotment advice, generally details of shares allotted are given, and when IDBI had issued 89,200 shares instead of one lakhd shares applied, it is clear that the shares were allotted. Without allotment the company cannot ask for allotment or call money, the allotment of shares is a prerequisite for asking the shareholders to pay further money after having received share application money and allotting shares it cannot be a case that company accepts application subject to further payment share application was accepted to the extent of 89,200 shares and therefore the shareholder was liable to payd further sum only in respect of such shares allotted in his favour. Even if there is some defective wordings are used  in allotment advice of IDBI, it will not change this posisition).

Accordingly  IDBI Limited cancelled the allotment ( as per author it should be forfeited shares) and forfeited the share application money of Rs. 32,50,000. As a consequence the holding of the assessee stood reduced and accordingly it resulted the loss of Rs. 32,50,000 to the assessee on account of such forfeiture.

The assessee claimed such loss as short-term capital loss in its return.

The A.O. and CIT (A) disallowed the loss:

The A.O. disallowed the loss for the main reason  that the allotment of shares were to be made only after receipt of the balance amount and on the date of forfeiture, shares in question were not yet allotted to the assessee. (per author there appears some mistake in this statement)

 The assessee had only received an allotment letter-cum-advice requiring it to deposit the balance amount for allotment of shares. (per author it should be allotment money and to make shares fully paid-up).

 It was further held that the allotment of shares was to be made only after the receipt of the amount which ultimately was not paid by the assessee, thus, according to him, the assessee did not get any right in the shares of the IDBI Limited.

Since it held that the assessee did not get any right in the shares, therefore, the relinquishment thereof did not arise.

 It was also held that there was no transfer involved in the instant case consequent to the forfeiture of shares application money in terms of provisions of section 2(47) read with section 45 of the Act.

The assessing officer disallowed the short-term capital loss as claimed by the assessee which the CIT(A) confirmed.

However, the Tribunal has allowed the appeal of the assessee and allowed the loss.

The revenue preferred the appeal under section 260A of the Act.

Per High Court:

Record shows that even though the assessee was informed by the IDBI Limited to deposit the balance amount of the share application money from time to time, but it did not take any action in this regard.

 Ultimately, vide letter dated 20-7-2000, the IDBI Limited cancelled the allotment of shares of the assessee and directed that the amount of the share application money stands forfeited with effect from 17-8-2000, as on or before 17-8-2000, the assessee had failed to deposit the balance amount of Rs. 83,46,000. In this view of the matter, the amount of Rs. 32,50,000 deposited towards share application money is forfeited.

To decide the question of law as formulated herein above, it is necessary to look into the definition of transfer as appearing in Section 2(47) of the Act, relevant portion thereof is reproduced herein below :

"2.(47) 'transfer', in relation to a capital asset, includes,—

(i) the sale, 'exchange' or relinquishment of the asset; or

(ii) the extinguishment of any rights therein ; or

(iii) the compulsory acquisition thereof under any law ; or

(iv) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment; "

The Tribunal has considered the meaning of the word "allotment", as appeared in the Guide to the Companies Act, 1956. The same is reproduced hereinbelow :

"What is termed 'allotment' is generally neither more nor less than the acceptance by the company of the offer to take shares. To take the common case, the offer is to take a certain number of shares or such a less number as may be allotted. That 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, This constitutes a binding contract to take that number according to the offer and acceptance. To my mind, there is no magic whatever in the term 'allotment' as used in these circumstances. It is said that the allotment is an appropriation of a specific number of shares. An allotment is an appropriation, not of specific shares, but of a certain number of shares."

 The above passage has been quoted in the Commentary of the Companies Act mentioned herein above from a decision in Florence Land and Public Works Co., In re (1885) 29 Ch D 421 at 426.

A binding contract existed between the assessee and the investee company, therefore the irresistible conclusion that can be drawn on the aforesaid facts and circumstances is that as soon as the allotment is made, the assessee would be deemed to have acquired a right in such shares even if the call monies or the full face value of the shares has not been paid.

Thus, in a case where only share application money is paid and the balance is yet to be paid on actual allotment of shares ( per author- shares are allotted, only issuance of share certificate may be afterwards), the holder of such allotment would be recognised as a member of the investee company. Thus, it cannot be said that the assessee had not acquired right in such shares on account of its failure to deposit the balance amount for allotment of shares.

The aforesaid view would attract the provisions of section 2(47) of the Act. The extinguishment of any rights therein as appeared in section 2(47) of the Act, covers every possible transaction 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.

 In the case on hand consequent to the assessee's default in not paying the balance of money on allotment, its right in the shares stood extinguished on its forfeiture by the investee company. The loss suffered by the assessee, i.e, non-recovery of share application money is consequent to the forfeiture of its right in the shares and the same is to be understood to be within the scope and ambit of transfer. In this view of the matter, the Tribunal was justified in holding that it would amount to short-term capital loss to the assessee. No other point was urged before us.

The court referred to and relied about  the extinguishment of any rights, to the judgment of the Supreme Court in the case of CIT v. Mrs. Grace Collis [2008 -TMI - 5986 - SUPREME Court]. In the said case, it has been held as under (page 329) :

"It is true 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."

For the aforesaid reasons the court held that " we are of the considered opinion that the questions posed have to be answered in favour of the assessee and against the revenue. The appeal accordingly stands disposed of."

Authors view:

In this case IDBI  Ltd allotted  89,200 shares, therefore the assessee was a shareholder of 89,200 shares which were partly paid-up and may carry voting rights only in ratio of capital paid-up on them. It is not generally case that shares shall be allotted later on as stated in the facts of the case.

Therefore, in view of author, and as discussed earlier, the shares were in existence, they were partly paid up, IDBI had a right to call further money and in case of failure to pay such further money it had a right to forfeit the shares and also the money paid on them. In opinion of author there cannot be cancellation of allotment, as stated in the facts. In case of cancellation of allotment, the application money shall be refundable. Cancellation of allotment mean not accepting the offer or cancelling the acceptance of offer, and that cannot be the case. There may be some mistake in communication from IDBI or mistake in recording of facts by authorities and may be the case was not properly presented.

Therefore, in case of forfeiture of shares the shares stand transferred to company who has a right to reissue the same. In case the Revenue carry the matter before the Supreme Court, the assessee can bring out correct facts and legal position in this regard.