1. With market rate of interest being in the neighbourhood of 15% a private company engaged in business, decided to reduce the fact value of its 3% non-cumulative preference shares from Rs. 1,000 to Rs. 50 (initially it was reduced to Rs. 500 and later on to only Rs. 50) and paid off Rs. 950 per share to its shareholders. This was done on the ground that there capital was in excess of the wants of the company. The assessee held 3% non-redeemable preference shares in this private limited company which were purchased at Rs. 420 per share. Thus, the assessee got back Rs. 950 for the share purchased at Rs. 420. When the first reduction took place the assessee who had paid Rs. 420 had already got Rs. 500 and the share cost to him was Rs. 80 per share. On subsequent paying off of Rs. 450 by reducing the face value from Rs. 500 to Rs. 50, he got back Rs. 450 per share of which his cost was Rs. 80. Under these circumstances the question giving rise to this petition which is formulated in the next breath has arisen.
2. When a company reduces its share capital by paying off a part of the paid up capital in exercise of powers under s. 100(1)(c) of the Companies Act, 1956 (and thus reduces its own liability vis-a-vis the shareholders) does it result in extinguishment of the right of the shareholders to the extent of the reduction of the face value of the share And the consequential question, if so, whether any profits or gains arising from such extinguishment are chargeable to income-tax under the head 'Capital gains' under s. 45 read with s. 2(47) of the I.T. Act of 1961, the extinguishment being considered as a transfer within the meaning of the aforesaid provision, is the question which confronts us in this reference at the instance of the assessee. The Income-tax Appellate Tribunal, Ahmedabad Bench 'C', having taken the view that income-tax was chargeable under the head 'Capital gains' under s. 4 in respect of all the profits or gains accruing to the assessee in the context of the aforesaid transaction pertaining to the assessment year 1967-68, the question has come up before us by way of the present reference under s. 256 of the I.T. Act.
3. The facts are not dispute. The assessee had purchased 90 non-cumulative preference shares of the face value of Rs. 1,000 at a price of Rs. 420 per share in a company carrying on its business under the name and style of 'Sarabhai Ltd.' In 1965 a sum of Rs. 500 per preference share was paid off to the assessee upon a reduction of the share capital of the company under s. 100(1)(c) of the Companies Act. The reduction of the share capital was effected by reducing the face value from Rs. 1,000 to Rs. 500 per share and by paying off Rs. 500 in cash. Thus, the assessee became a holder in respect of 90 non-cumulative preference shares of the value of Rs. 500 in place of the holding of shares of the face value of Rs. 1,000. In 1966 a further reduction was effected under the same provision pursuant to an order confirming the reduction of capital passed by the competent court. By virtue of the reduction so effected it reduced its liability on the preference share from Rs. 500 to Rs. 50 by paying off in cash a sum of Rs. 450 per share. Thus, the shares held by the assessee which were originally of the face value of Rs. 1,000 became shares of the face value of Rs. 50 only. We are not concerned with the first reduction effected in 1965 from Rs. 1,000 to Rs. 500. We are concerned with the second reduction in 1966 whereby the face value was reduced from Rs. 500 to Rs. 50. It is not in dispute that these shares were originally purchased at Rs. 420 per share and as a result of the said reduction the assessee had got back Rs. 950 in all (Rs. 500 per share in 1965 and Rs. 450 per share in 1966). It is not in dispute that if the transaction is question was construed as one falling within the defination of 'transfer' as embodied in s. 2(47) of the Act read with s. 45 of the Act capital gains tax would be attracted. The contention of the assessee is that s. 45 of the Act is not attracted inasmuch as there is no extinguishment of the assessee's right as contended by the Revenue and that accordingly there is no transfer within the meaning of the aforesaid provision. It was argued that it merely constitution repayment of what was due to the assessee and the transaction in question would not, therefore, amount to an extinguishment so as to bring it within the definition of 'transfer'. The Tribunal has taken the view that the ITO was right in holding that the transaction in question resulted in an extinguishment of the rights of the assessee in the shares in question and that the AAC was in error in taking a contrary view. Thereupon the present reference has come to be made at the instance of the assessee. Reliance has been placed by the assessee on CIT v. R. M. Amin : 82ITR194(Guj) , as confirmed by the Supreme Court in : 106ITR368(SC) , in support of the proposition that a transaction of this nature would not fall within the description of transfer. The expression 'transfer' has been defined in s. 2(47) of the Act in the following terms :
'2(47) 'Transfer', in relation to a capital asset, includes the sale exchange or relinquishment of the asset or the extinguishment or the asset of the extinguishment of any rights therein or the compulsory acquisition thereof under any law.'
4. The view taken by the Tribunal is that the transaction of reduction amounts to an extinguishment of the right of the assessee in the preference shares in question and that on the account the transaction would fall within the ambit of the expression 'transfer'. The question, therefore, is whether an extinguishment of any rights of the assessee has been brought about by reason the transaction of reduction of capital. R. M. Amin's case does not directly deal with a similar situation. The Tribunal has taken the view that the ratio of the said decision cannot come to the rescue of the assessee in support of his plea that the transaction in question does not result in the extinguishment of any of his rights and does not, therefore, constitute 'transfer' within the meaning of s. 2(47) of the Act. In order to extract the ratio of the decision in R. M. Amin's case : 82ITR194(Guj) , a few facts are required to be stated. The assessee in that case was a shareholder of a company which went into liquidation. The liquidator sold the assets of the company in due course. And, as there was surplus the assessee became entitled to receive a particular amount as written-off capital in respect of the shares which were held by him in the company which was taken into liquidation. It was in that context that the question arose whether the payment made to the assessee could be treated as 'transfer' within the meaning of s. 2(47) of the Act and whether the profits arising from the said transaction were exigible to tax under the head of 'Capital gains'. A Division Bench of this High Court, speaking through P. N. Bhagwati C.J., as he then was, has taken the view that the monies received by the assessee were not paid to him by reason of the extinguishment of any of his rights and no question of transfer or capital gains could arise in that view of the matter. The basis of the reasoning was that a shareholder has three distinct rights in his capacity as a shareholder of a company, viz., (1) the right to dividend out of the profits of the profits of the company, (2) the right to attend and vote at the meetings and thereby indirectly participate in the management of the company, and (3) the right to share in the distribution of the net asset on the winding up of the company. The amount paid to the assessee was paid in the context of his right which fell under category No. 3, viz., the right to share in the distribution of the net assets on the winding up of the company. Since the company was taken into voluntary liquidation, the only right that the assessee had, was the right to share in the distribution of the net assets. Since there was a surplus and some assets were available for distribution amongst the shareholders, the same were distributed in the course of winding up by the official liquidator. In the context of this fact-situation the Division Bench concluded that the moneys received by the erstwhile shareholder were not on account of any extinguishment of his right in the shares held by him. The amount was paid to him not because any of him rights in the shares were extinguished. The amount was paid to him because that was the only right that he had as a shareholder consequent to the winding up of the company. It is in this context that the Division Bench has enunciated the position of law in the following terms (p. 195) :
'When a shareholder receives moneys representing his share on distribution of the net assets of the company in liquidation, he receives such moneys in satisfaction of the right which belongs to him by virtue of his holding the share and not by way of consideration for the extinguishment of his right or rights in the share. It is not the extinguishment of his rights in the share and not by way of consideration is received by him; it is rather because moneys representing his share in the distribution are received by him that his rights in the share are extinguished. Therefore, when a shareholder receives his share on final distribution of the net assets of the company in liquidation, there is no transfer of capital asset by him which would attract the charge of capital gains tax under section 45.'
5. What emerges from the aforesaid decision is that what the shareholder got was the right which he had, viz., the right to share in the distribution upon winding up. Till the company was taken into voluntary liquidation, he had a right to share in the profits and vote at the meetings. Once the company was taken into voluntary liquidation, the only right that he had in the company was a right to participate in the distribution of the net assets and it was this right which was worked out or satisfied upon the payment being made to him from out of the net assets. Such a payment being one which was in accordance with and on account of the rights which he had under the law when the company was taken into voluntary liquidation, it was futile to contend that any of his rights was extinguished. It was not because any right was extinguished that payment was made but it was because his only right was the right to share in the distribution in the net assets upon widing up, that amount was paid. Such is the basis of the reasoning which resulted in the conclusion that there was no transfer. No extinguishment of right had taken place and, therefore, there was no question of any transfer. That is the sum and substance of the proposition which emerges from R. M. Amin's case : 82ITR194(Guj) . The Supreme Court has confirmed this view and has declared the law on the subject in : 106ITR368(SC) , in the following terms (Headnote) :
'When a shareholder received money representing his shares on the distribution of the net assets of the company in liquidation, he received that money in satisfaction of the right which belonged to him by virtue of his holding the shares and not by any operation of any transaction which amounted to sale, exchange, relinquishment, or transfer of a capital asset or extinguishment of any rights in capital assets.'
6. Thus, the Supreme Court has, in terms, declared that the money paid to the shareholder was on account of or by reason of the right which belonged to him, viz., the right to share in the net assets of the company upon its going into liquidation. What needs to be emphasised is that the rationale of the conclusion, that a payment made to a shareholder upon the distribution of the assets upon a winding-up does not constitute an extinguishment of any right, rested on the circumstances that the distribution was made not because any right belonging to the shareholder was extinguished but by reason of the fact that he had such a right, viz., the right to share in the distribution of the net assets. When what was paid to him was by reason of and on account of and thus in satisfaction of his right, it cannot be said that any of his rights was extinguished. This reasoning cannot apply to a situation arising in the context of the reduction of share capital. When the share capital is reduced by paying off a part of the capital by reducing the fact value of the share, the share remains but the right of the shareholder to dividends on his share capital and the right to share in the distribution of the net assets upon liquidation is extinguished proportionately to the extent of the reduction in capital. Till the reduction took place, the shareholder had a right to dividend on a capital of Rs. 1,000 per share. He also had a right to distribution in the net assets of the company in case of liquidation on the footing that his capital was Rs. 1,000 per share. Upon a reduction of the face value of the share from Rs. 1,000 to Rs. 500 and later on to Rs. 50, his right in the share in question stood extinguished to the proportionate extent. Instead of the right to receive dividend on Rs. 1,000 all that he retained was a right to dividend on Rs. 500 upon the first reduction and a right to receive dividend on Rs. 50 upon the second reduction. The only other right that he had in his capacity as a shareholder of the company was to a share in the distribution of the net assets in case the company went into liquidation. That right was also extinguished to the proportionate extent in the sense that instead of being entitled to share in the distribution of the net assets on the footing, that his capital was Rs. 1,000 he would get a share on the footing that his capital was only Rs. 50. Therefore, there has been an extinguishment of his right to the aforesaid extent in two respects, viz., (1) in respect of the right to dividend, and (2) in respect of the right to share in distribution. No doubt he continues to remain a shareholder, but the right in the share as originally held by him stands extinguished to the aforesaid extent in the aforesaid manner. It is, however, argued on behalf of the assessee that the reduction so brought about cannot be considered to result in any extinguishment of his right at all. The argument is that it is merely a payment made of the shareholders in satisfaction of his right as a shareholder. In our opinion, this submission is altogether misconceived. The shares held by him were not redeemable preference shares. He had no right to claim a return of the entire share capital or any part of the share capital during the subsistence of the company. He could not have insisted upon the reduction of the capital. He could not have claimed as a matter of right that his capital be refunded to him fully or partly. Therefore, it is specious to contend that the payment made to him is by virtue of any right that he had in his capacity as a shareholder. Be it realised that when we use the expression 'right', we use it in the sense of any right which the shareholder could have asserted or exercised under the law. It is no doubt true that the company had the right to reduce its share capital by following the appropriate procedure, whether or not the shareholder was agreeable to it, the company was entitled to reduce the share capital and to pay off a part of the share capital if a special resolution as contemplated by s. 100 of the Companies Act was passed in the aforesaid manner. It was, therefore, an act of the company which had the consequence of extinguishing of the right of the shareholder to the aforesaid extent. The payment is made not because the shareholder was entitled to a refund of his share capital. It was made because the company had decided to reduce its liability by extinguishing the right of the aforesaid extent. The provision contained in s. 100(1)(c) of the Companies Act provides that company has a right to extinguish or reduce the liability in respect of the shares by paying off the paid up share capital which is considered to be in excess of its requirements. The said provision, in so far as material, reads as under :
'100(1) Subject to confirmation by the court, a company limited by shares or a company limited by guarantee and having share capital may, if so authorised by its articles, by special resolution, reduce its share capital in any way; and in particular and without prejudice to the generality of the foregoing power, may - ....
(c) either with or without extinguishing or reducing liability on any of its shares, pay off any paid-up share capital which is in excess of the wants of the company;
and may, if and so far as is necessary, alter its memorandum by reducing the amount of its share capital and of it shares accordingly.'
7. When the shareholder had not right to demand a refund of his share capital by insisting that it should extinguish or reduce its liability to the shareholder by doing so, how can it be contended that the payment was made to the shareholder in satisfaction of his right and not on account of the extinguishment of his right As discussed earlier, his right to dividend in the profits on the face value of Rs. 1,000 is partly extinguished as a result of the first reduction and he has a mere right to a dividend on the share capital of Rs. 500 though he no doubt continues to be a shareholder of the company. By the second reduction his right to receive a dividend from out of the profits on the share capital of Rs. 500 stands extinguished partly and his right is now restricted to claim a dividend on Rs. 50. Similarly, his right to share in the distribution on the footing of a share capital of Rs. 1,000 stands reduced upon the first reduction and by a further Rs. 450 by the second reduction. It is, therefore, clearly a case of extinguishment of his right. It is not as if in his capacity as the preference shareholder he stood in the position of a creditor vis-a-vis the company. He had no right to demand refund or reduction of capital by paying off a part of the capital. He did not have any such right. No such right is extinguished and no payments has been made on account of any such right or in lieu of such a right. It cannot, therefore, be said that the payment has been made in satisfaction of these rights. The payment has been made because his right in the shareholding in respect of reference shares which were of the face value of Rs. 1,000 originally was extinguished to the extent of Rs. 500 per share by the first reduction and to the extent of further Rs. 450 by the second reduction. The payment made to him is on account of the extinguishment of his right to the aforesaid extent and on no other account. Such being the position the basis of the reasoning in R. M. Amin's case : 82ITR194(Guj) , is of no avail to the assessee. The Revenue seeks to reinforce its submission on this point by recourse to the reasoning which found favour with a Division Bench of this High Court in CIT v. Minor Bababhai : 128ITR1(Guj) . The question arose in the context of the fact that the debt due to the assessee in that case under a promissory note held by him was scaled down by 55% by way of a scheme of compromise framed in the course of winding-up proceedings instituted against a company. The assessee had to let off 55% of his claim with interest under the scheme and in consideration thereof he received 45% of the balance without interest by instalments and became entitled to equity shares of Rs. 50 each to the extent of 5% of his claim without interest. The court took the view that it constituted a novation and the payment which was made to him, was in the context of the scheme and/or agreement sectioned by the court, whereby he was paid 45% of the original amount without interest along with the equity shares, and was not in repayment of the original debt under the promissory note. The court upheld the contention that the capital asset which originally belonged to the assessee no longer remained in existence. A new right had arisen in his favour by reason of the scheme. The old contractual rights between the parties got substituted by new rights which resulted in the extinguishment of the assessee's right in the erstwhile capital asset. On this reasoning the court took the view that the assessee was entitled to claim a short term capital loss of Rs. 11,617 which represented the difference between the valuation of the original asset on the one hand and the payment that was received under the scheme on the other. The essence of the matter is that though there was a debtor-creditor relationship initially the shortfall in the amount received under the scheme was considered as resulting in a capital loss on account of an extinguishment of the original right by reason of the substitution of the right under the promissory note by the right under the scheme. In the present case the Revenue is, therefore, justified in contending that to the extent that his original right before reduction was substituted by a new right, upon reduction, there was an extinguishment of his right in the shareholding. In a way, therefore, the decision in Minor Bababhai's case : 128ITR1(Guj) , lends support to the view canvassed by the Revenue. The House of Lords in Scottish Insurance Corporation Ltd. v. Wilsons and Clyde Coal Co. Ltd.  AC 462;  1 All ER 1068;  19 Comp Cas 202 , has referred to the consequence of a return of capital to the holder of preference shares as amounting to an 'extinguishment'. Therein, it is observed as under (see the speech of Lord Morton at pp. 498 and 499-see also p. 1085 of  1 All ER 224 of 19 Comp Cas) :
'My Lords, the respondent company (hereinafter called 'the company') seeks to effect a reduction of its capital by returning to the holders of its Pound 40,000, first preference stock and Pound 10,000 second preference stock capital to the full extent of Pound 1 in respect of each Pound 1 of such stock held by them respectively and thereby extinguishing these two stocks, and by returning to the holders of its Pound 675,000 issued ordinarily stock capital to the extent of 10s in respect of each Pound 1 of such stock held by them respectively. This reduction can only be carried out subject to confirmation by the court and the court will not confirm the reduction unless it is 'Fair and equitable'.'
8. Counsel for the assessee has sought support from CIT v. G. Narasimhan : 118ITR60(Mad) . The ratio of the said decision does but tress the proposition canvassed by the assessee. It is a decision directly in his favour in the context of a fact situation similar to the one obtaining in the present case. It was a case of reduction of capital. A Division Bench of the Madras High Court has taken the view that the payment made in the context of reduction would not constitute extinguishment of the right of the shareholder and that it is not a transfer within the meaning of s. 2(47) of the Act. In order to appreciate the basis of the reasoning which commended itself to the Madras High Court, it is necessary to reproduce the following passages from pp. 70 and 71 of report :
'The only other aspect of the argument that has to be consider is whether there has been any extinguishment of any of capital assets held by the shareholder as a result of the reduction of capital in the company. It was contended that there has been such extinguishment of the rights of the shareholder. We are not able to conceive how there has been such extinguishment. All the rights of the shareholder as a shareholder in the company still remains. He continues to hold the same number of shares. Whether, on liquidation, he would get the amount which he would have received had a liquidation taken place at the time of the reduction of capital cannot touch the question as to whether by the reduction of capital there has been any extinguishment. It is conceivable that he would receive less in the event of the winding up of the company after reduction of capital in view of the fact that there has been distribution assets. But on the possibility of the company not prospering and not arguementing its assets, it is not possible to come to any conclusion that there has been any extinguishment of the rights of the shareholder. The shareholder's right to receive the assets of the company, as we said earlier, can arise only in the event of winding up of the company and on liquidation taking effect. That event not having taken place, we cannot postulate any extinguishment. Apart from this, the very argument advanced indicates that there has been no extinguishment. The argument which we noticed earlier was that the shareholders had received more than the equivalent of the reduction in the value of the shares. Whether there is any such exchange between the company and the shareholder of the company has been already dealt with and we have come to the conclusion that there has been no such exchange. We are now referring to the argument on behalf of the Revenue only to emphasis that even according to their case, there has been no extinguishment of the rights of the shareholder. We have, therefore, to reject this part of the argument as well.'
9. It would appear that considerable importance was attached to the circumstances that all the rights of the shareholder as a shareholder in the company remained in the sense that the shareholder continued to hold the some number of shares. In our opinion (saying so with respect), whether or not the number of shares held by the shareholder remained the same or not was not a factor which would be decisive for the purpose of ascertaining whether or not there was any extinguishment in the shares. The number of shares remained the same but the face value of the shares was reduced and there was a proportionate curtailment of his right in respect of the right to receive dividend and to share in the net assets of the company upon liquidation. This aspect of the matter has not been considered to be a matter of any consequence by the Madras High Court as is evident from the following observations extracted from the said passage (p.71) :
'Whether, on liquidation, he would get the amount which he would have received had a liquidation taken place at the time of the reduction of capital cannot touch the question as to whether by the reduction of capital there has been any extinguishment. It is conceivable that he would receive less in the event of the winding up of the company after reduction capital in view of fact there has been distribution of assets. But on the possibility of the company not prospering and not augmenting its assets, it is not possible to come to any conclusion that there has been any extinguishment of the rights of the shareholder. The shareholder's right to receive the assets of the company, as we said earlier, can arise only in the event of winding up of the company and on liquidation taking effect. That event not having taken place, we cannot postulate any extinguishment.'
10. Again saying so with respect, we are unable to agree with this part of the reasoning which found favour with the Division Bench of the Madras High Court. We fail to comprehend why the fact that the shareholder would get dividend on a lesser amount and would get a lesser amount upon the distribution of the net assets upon winding up is irrelevant. To the extent that his right in this behalf is curtailed, there is an extinguishment of his right notwithstanding the fact that he continues to be a shareholder. Of the other rights which he had as a shareholder barring the right to vote at the meeting (with which we are not concerned for the present purposes) his economic rights in the shares have been curtailed and extinguished, as discussed earlier, to the extent of reduction. It is, therefore, not possible to agree with the proposition that this aspect has no bearing on the question. We are not concerned with the question as regards the possibility of the company prospering or not prospering and augmenting or not augmenting its assets. Whether the company prospers or not, whether there is an augmentation or not, the right of the shareholder in respect of his shareholding would get curtailed. It would remained curtailed. The curtailment or extinguishment does not prosper. On the date of the reduction there is a proportionate extinguishment. Extinguishment means extinguishment as regards his present right to claim dividend on the basis of the shares held by him. Instead of the right to claim dividend on the shares linked to the face value of Rs. 1,000 the right that now remains is the right to claim dividend linked to a share with the face value of Rs. 500 and subsequently to the face value of Rs.50. Thus, his present right in respect of dividend out of the profits does stands extinguished to the aforesaid extent apart from the right arising upon the winding up of the company. If his right is not extinguished to the aforesaid extent,he must be entitled to claim a dividend on the original capital prior to the reduction. Thus, it is not possible to hold that there has been no extinguishment. There has been an extinguishment in reality in the aforesaid sense and to the aforesaid extent. And that extinguishment is the consequence of the decision of the company. It has no nexus with the right of the shareholder to a refund of the share capital. It has nexus with the decision of the company to pay off a part of the share capital. Thus, as a result of the act of the company coupled with the payment of the proportionate amount, the right of the shareholder stands extinguished protanto. Such being the position we are unable to concur with the view taken by the Madras High Court in the aforesaid decision.
11. In the result, the question referred to us in both the reference requires to be answered in the manner indicated hereinbelow :
I.T.R. No. 68/76 :Question AnswerWhether, on the facts of the case, In the affirmative andthe Tribunal rightly held that the against the assessee.assessee had made capital gains onthe reduction of preference sharecapital which was exigible to capitalgains tax ?I.T.R. No. 369 :Whether, on the facts and in the In the affirmative andcircumstance of the case, the against the assessee.Tribunal was justified in holdingthat the assessee had made capitalgain of Rs. 28,710 as a result ofreduction in preference sharecapital of Sarabhai Ltd. ?
12. Both the reference answered accordingly with no order regarding costs. Counsel for the assessee makes an oral question for a certificate of fitness for appeal to the Supreme Court as envisioned by s. 261 of the Act. In view of the fact that we are taking a view different from the view taken by the Madras High Court, we are of the opinion that is a fit case for appeal to the Supreme Court. Certificate is, therefore, granted.