Selective Capital Reduction and Asset based Payout

Background of the case

In a recent ruling the NCLT had examined a scheme involving selective capital reduction and distribution of assets-based payouts by an Indian company (‘the Company’). The scheme involves distributing of shares held in few subsidiaries (assets held by the Company) to four identified investors (‘the Investors’) as compensation for the reduction of their shareholding, rather than a cash payout. The objective was to facilitate the exit of the Investors while optimizing the Company’s capital structure.

Key Issues

• Whether selective capital reduction possible and whether it could be detrimental to other shareholders?
• Whether Section 66 permits share capital reduction by way of asset-based payouts?

Key Takeaways

1. Selective capital reduction

• Selective capital reduction refers to reducing the share capital by targeting specific shareholders rather than uniformly across all shareholders.
• In the instant case, the process met the requirements of Section 66, which allows for capital reduction “in any manner” approved by a special resolution. The NCLT held that selective reduction is permissible if approved by the majority shareholders and does not affect the rights of creditors or remaining shareholders. It relied on Reckitt Benckiser (India) Ltd. and Chawla Brothers Pvt. Ltd. cases.

2. Capital reduction by way of asset-based payouts

• In this case, the Company compensates shareholders with non-cash assets (i.e. shares of subsidiary companies) instead of direct cash payments.
• The NCLT approved such distribution of asset-based payout pursuant to capital reduction scheme and it ruled as compliant with Section 66 of the Companies Act, which allows capital reduction “in any manner”. It relied on the Shrem Infraventure Pvt. Ltd., Vodafone India Ltd. and other NCLT and High Court rulings where non-cash compensation in capital reduction was upheld.
• The scheme faced questions about alignment with Sections 52 and 66, and concerns about potential tax avoidance. The Company addressed these by committing to compliance with tax laws, securing regulatory approvals, and ensuring transparency in its transactions.

Other aspects

• The NCLT mandated that the Income Tax Department retains the right to scrutinize and enforce applicable tax laws.
• Compliance with RBI regulations was made a condition for implementation.

Conclusions

The NCLT approved the scheme, ruling that it complied with the Companies Act and safeguarded stakeholder interests. The decision validates selective capital reduction and asset distribution as legitimate methods for facilitating investor exits.This case underscores the balance between shareholder rights, regulatory adherence, and tax compliance in corporate restructuring.