FORFEITURE OF SHARES AND TAX IMPLICATIONS

*BY CA A. K. JAIN & MS. SONI KUMARI

The forfeiture of shares refers to loosing the right in the shares by the Share Holders for non-payment of call money or balance amount. Any action in this regard has tax implications for the company forfeiting the shares. Moreover, it should be carefully planned and executed with due compliance and consideration of the provisions of Companies Act.

Regulation  28

If a member fails to pay any call, or installment of a call, on the day appointed for payment thereof, the Board may, at any time thereafter during such time as any part of the call or installment remains unpaid, serve a notice on him requiring payment of so much of the call or installment as is unpaid, together with any interest which may have accrued. 

Regulation 29 

The notice aforesaid shall mention -  

(a) Name a further day (not being earlier than the expiry of fourteen days from the date of service of the notice) on or before which the payment required by the notice is to be made; and 

(b) State that, in the event of non-payment on or before the day so named, the shares in respect of which the call was made will be liable to be forfeited. 

Regulation  30        
If the requirements of any such notice as aforesaid are not complied with, any share in respect of which the notice has been given may, at any time thereafter, before the payment required by the notice has been made, be forfeited by a resolution of the Board to that effect.

Regulation 31         
A forfeited share may be sold or otherwise disposed of on such terms and in such manner as the Board thinks fit. At any time before a sale or disposal as aforesaid, the Board may cancel the forfeiture on such terms as it thinks

Procedure For Forfeiture Of Shares

1. A forfeiture of any share must be done on the authority of the Board of Directors, or of committee thereof, if authorised by articles of associations for the purpose, by its resolution. The resolution should provide for a notice to be given to the shareholder concerned before the forfeiture is actually effected in pursuance of the resolution, requiring payment of so much of the calls as is unpaid, together with any interest which may have accrued.

2. The notice threatening forfeiture in pursuance of the Board Resolution must be given in accordance with the provisions of the articles. The notice aforesaid shall:

* name a further day (not being earlier than the expiry of 14 days from the date of service of notice) on or before which the payment required by the notice is to be made; and

* state that, in the event of non-payment on or before the day so named, the shares in respect of which the call was made will be liable to be forfeited.

3. The Notice Must:

* specify clearly the amount payable on account of unpaid call money as well as interest accrued , if any, and other expenses.

* mentioned the day on or before which the amount specified ought to be paid, not being earlier than 14 days from the date of service of notice

* contain an unambiguous statement to the effect that in the effect of failure to pay the specified amount latest on the appointed day, the shares in respect of which the amount remain un paid would be liable to be forfeited.

4. The notice threatening forfeiture as contemplated in regulation must be served in accordance with the provisions of section 20 of the Companies Act, 2013.

5. If the call money is not paid in response to such notice threatening forfeiture, the company may, at any time thereafter, before the payment required by the notice has been made, forfeit the shares by a resolution of the Board to the effect.

6. It is common practice to publish a notice of forfeiture in newspapers so that the members of the public are made aware of the forfeiture and cautioned not to deal in the forfeited shares.

7. A further notice after the shares are forfeited is not necessary. However, it is advisable and a common practice to give a notice of the shares having been forfeited to the concerned shareholders by registered post.

8. Regulation 33     
* A duly verified declaration in writing that the declarant is a director, the manager or the secretary, of the company, and that a share in the company has been duly forfeited on a date stated in the declaration, shall be conclusive evidence of the facts therein stated as against all persons claiming to be entitled to the share. 

*The company may receive the consideration, if any, given for the share on any sale or disposal thereof and may execute a transfer of the share in favor of the person to whom the share is sold or disposed of.

* The transferee shall thereupon be registered as the holder of the share.

* The transferee shall not be bound to see to the application of the purchase money, if any, nor shall his title to the share be affected by any irregularity or invalidity in the proceedings in reference to the forfeiture, sale or disposal of the share.

9. The fact of the forfeiture will be entered in the Register of Members and the name of the concerned shareholder as a member of the company will be deleted from the register.

10. Notify the Stock Exchange at which the securities of the Company are listed about such forfeiture of shares.

Time within which shares are to be made fully paid-up

(i) As per the SEBI Guidelines, capital issues henceforth have to be made fully paid-up within 12 months.

(ii) Where the total issue size exceeds Rs. 500 crores:-

(a) It is not necessary to make the capital issue fully paid-up within 12 months.

(b) The amount to be called up on application, allotment and on various calls should not each exceed 25 per cent of the total quantum of the issue.

(c) The company should make arrangements for monitoring of the use of proceeds of the issue by one of the financial institutions.

(d) A copy of the monitoring report must be filed with SEBI by the financial institution and by the company for the purpose of record.

Forfeiture Notice & Resolutions 

Notice for Board Meeting 

Notice is hereby given that the Board of directors of the company at their meeting held on …………… have forfeited …………… Equity Shares of Rs. 10 each on account of non-payment of amount due on First Call from the concerned shareholders.

You are advised that please do not transact on any partly paid up shares and return the same to the company for record. Company have also canceled all such shares after forfeiture. If anybody transact in those forfeited shares the company shall not be responsible to such transactions.

By Order of the Board

Director

Place:

Date: ……………….

Declaration in respect of forfeiture of shares

I, SKJ Director of ABC Ltd. solemnly and sincerely declare that:—

1. The persons whose names and addresses are given in Annexure 1 were on ....... the registered shareholder of the Company (hereinafter referred to as "defaulting Equity Shareholders")

2. On ................ a call for unpaid allotment money on shares to be paid on or before ....... was made and accordingly notice of such call was duly given to the defaulting Equity Shareholder.

3. On ........……. reminder letters to pay the allotment money were sent to all the defaulting shareholders who failed to pay the allotment money before the due date.

4. The defaulting Equity Shareholders having failed to pay the call by the appointed day notices in writing were given to them on followed by a reminder dated ...... informing them that on their failure to pay the allotment money their shares would be forfeited.

5. The defaulting Equity Shareholders having failed to pay such unpaid allotment money, their shares were duly forfeited by the Board of directors at its meeting held on .......... and notices of such forfeiture were given to the defaulting Equity shareholders.

6. The Company is now entitled by Articles .......... of its Articles of Association to sell such forfeited shares. AND as per Article........ of  Articles of Association of the Company, I make this solemn declaration conscientiously having the same to be true.

Board Resolution for forfeiture of Shares -    
RESOLVED THAT pursuant to Article No…. of the Articles of Association of the company and other applicable provisions of the Companies Act, 2013, if any, consent of the Board of Directors of the Company be and is hereby accorded for forfeiture of ………….. partly paid up Equity Share of Rs. 10 each on which total Rs. ……………. at the rate of Rs. …. per share remains unpaid on account of Share Capital & Share Premium account due to failure to pay the balance amount of allotment money due thereon as per list of partly paid up shares placed before the Board, duly initialed by the Chairman for the purpose of identification, reproduced hereunder:

Folio NO.                    No. of Shares               Name of Shareholder

1.

2.

3.

“RESOLVED FURTHER THAT the Share Transfer Agent M/s ……………… be and is hereby authorised to make entries in the register of members for giving effect to forfeiture of all the ……………….. partly paid up Shares.”

 “RESOLVED FURTHER THAT Shri ………. and Shri…………DSJ, Directors of the Company be and are hereby severally and / or jointly authorised to inform to the Stock Exchanges, SEBI and all such authorities about the decision of the Board for forfeiture of ………………. partly paid up equity shares of the company and to do all such acts, deeds and things as may be necessary, expedient and desirable to give effect to the above resolution.”

Forfeiture & Income Tax Law:

Income Tax Act does not provide any provision for dealing with forfeiture of share or debenture issue application money. Share application money or money received for debentures are common source of money for companies. It happens many times that the share applicant does not subscribe to shares after initial application for issue of shares or debentures. In that case the companies may forfeit the initial share or debenture money receipt.

Majority decision of tribunal and courts have suggested that such forfeiture of money by company is not taxable as it is capital receipt . Following three judgments are analysed DCIT vs Brijlaxmi Leasing and Finance Ltd. (2008) 12 DTR 150 Deepak Fertilisers and Petrochemicals Corpn. Ltd. vs DCIT 116 ITD 372 Prism Cement Ltd. vs JCIT 285 ITR 43 ITAT, of Mumbai 1. Deepak Fertilisers and Petrochemicals Corpn. Ltd. vs DCIT 116 ITD 372 

The next issue relates to the addition on account of forfeiture of the application money received against issue of partly convertible debentures. The assessee had issued partly convertible debentures in Financial Year 1989-90 against which it received application money. However, after the allotment the applicants could not make the payments as per the terms of the issued debentures. In the Assessment Year 1999 2000, the assessee forfeited the sum of Rs. 87.22 lakhs on account of non-payment of call moneys and credited the sum to the Profit and Loss A/c. Similarly, the sum of Rs. 6,36,949/- was forfeited in Assessment Year 2000-01.            

This amount was not offered for taxation by the assessee. In the course of assessment proceedings the assessee was asked to show cause why such amount should not be treated as income in view of the Supreme Court judgment in the case of K.V. Sundaram Iyengar and Sons Ltd. 222 ITR 344. In response to the same, it was submitted before the Assessing Officer that the said judgment is applicable only when the money was initially received from the customers as trading receipt i.e. during the course of carrying on its business. Therefore, the said judgment cannot be applied where the money is not received as a trading receipt. Since, the forfeiture is related to debentures, the amount received was capital in nature and therefore it cannot be treated as Revenue receipt when such amount is forfeited.  

Not satisfied with the explanation of the assessee, the Assessing Officer made the additions in computing the total income of the above assessment years. Held as under: Similar view has been taken by the Tribunal in the case of Prism Cement Ltd. 101 ITD 103 (Mum) In that case, the company issued certain non-convertible debentures and some of which were forfeited due to non-payment of call money. The Bench held that forfeiture amounted to capital receipt and the same could not be charged to tax.

This case was decided after considering the Supreme Court judgment in the case of T.V. Sunderam Iyer and Sons Ltd.(supra) The facts of the present case are similar to the facts before the Tribunal in the case of Prism Cement Ltd.. Therefore, following the same, the orders of the learned CIT(A) are upheld.2. DCIT vs Brijlaxmi Leasing and Finance Ltd. Download I.T.A. No. 515/Ahd/200, Assessment year 1999-2000 The facts The brief facts of the case are that the assessee-company made public issue of shares against which it received share application money from the shareholders.   

The allotment money of these shares was to be paid according to the terms of offer of the public issue. Some of the shareholders had not paid the allotment money as stipulated within the time allowed as per the terms of offer and further time offered by the assessee. Subsequently, since no payment against allotment money were received, the assessee forfeited the shares and credited the sum of Rs.1, 23, 31,000 to the capital reserve account. The Tribunal held as under we have heard the rival submissions and per used the orders of the lower authorities and the material available on record. In the instant case the assessee was to receive call money in respect of share as per the terms of prospectus and the allotment letters, but the same were not received from some of the shareholders. In this case, the share application money was forfeited as per the terms of the prospectus. The above facts are not in dispute.        

The short question which falls for our consideration is whether the above forfeiture amount is taxable under the provisions of the Income-tax Act, 1961, or not. The learned Departmental representative vehemently placed reliance on the decision of the Hon’ble Supreme Court in the case of CIT v. T. V. Sundaram Iyengar and Sons Ltd. [1996] 222 ITR 344 for his contention that forfeited amount is taxable as revenue receipt. However, we find that the facts of the case that were before the Hon’ble Supreme Court are distinguishable from the facts before us. In the instant case no security deposit or advance received for performance of the contract was forfeited. In fact, the amount received was against issue of shares and issue of shares is not the business of the assessee. The same cannot be treated as a receipt in the normal course of the business of the assessee which is engaged in financing and leasing business. Further, the assessee has also not credited the forfeited amount in its profit and loss account but in contradistinction to that it has credited the same in capital reserve account.           

In the above facts, in our considered opinion the decision of the Tribunal in the case of Prism Cement Ltd. v. Joint CIT [2006] 285 ITR (AT) 43; [2006] 103 TTJ (Mum) 63 is more applicable which was rendered by the Tribunal after duly considering the aforesaid decision of the Hon’ble Supreme Court in the case of CIT v. T. V. Sundaram Iyengar and Sons Ltd. [1996] 222 ITR 344. The Tribunal in the said case has held as under (page 54 of 285 ITR (AT)): “15. Thus, the earnest money or an advance amount received on account of issuance of NCDs, if forfeited on account of non-payment of call money, the loan liability would only convert into a capital receipt. It would not assume the character of revenue receipt or business receipt because NCDs were not issued in the course of regular business of the assessee as evident from the facts of the case. The assessee’s main business is of cement and it was in the process of set up of cement manufacturing plant at Satna during the impugned assessment year. In these circumstances, we are constrained to hold that the amount received by the assessee in lieu of issuance of NCDs which were forfeited later on account of non-payment of call money assumes the character of capital receipt which earlier was shown as a loan liability in the books of account of the assessee.

If we consider this receipt to be business receipts even then it would not be taxable to tax under the provisions of section 41(1) of the Act, inasmuch as there was no allowance or deduction of this liability in the earlier years.” In view of the above, respectfully following the aforesaid decision of the Mumbai Bench of the Tribunal we find no reason to interfere with the order of the learned Commissioner of Income-tax (Appeals). It is confirmed and the ground of appeal of the Revenue is dismissed. In the result, the appeal of the Revenue is dismissed.  

The order signed, dated and pronounced in the open court on February 29, 2008. 3. Prism Cement Ltd. vs JCIT 285 ITR 43 [ITAT, of Mumbai in] the assessee has issued 38 lakhs debentures, 13.5 per cent non-convertible debentures of Rs. 150 each. During the previous years relevant to the impugned assessment year, 62,250 non-convertible debentures (NCDs) were forfeited due to non-payment of call money. This can be re-issued at the option of the assessee. On account of forfeiture of debentures, the amount paid earlier on such debentures have been written back. In “Schedule D” of the Audited Accounts, the assessee credited an amount of Rs. 14.19 lakhs being the amount written back on forfeiture of debentures and set it off against the expenditure of Rs. 6,482.59 lakhs.

According to the Assessing Officer, though the commercial production had not been commenced by 31-3-1993 the monies were borrowed through non-convertible debentures for the purpose of business. As NCD’s holders defaulted in making payment of the call money, they lost the right to retrieve the amount paid and the forfeited NCDs can be re-issued upon the option of the assessee only. Thus, the benefit has been derived by the assessee-company in monetary terms and the same was liable to be taxed as income of the assessee. The Tribunal Held as under Thus, the earnest money or an advance amount received on account issuance of NCDs, if forfeited on account of nonpayment of call money, the loan liability  would only convert into a capital receipt. It would not assume a character of revenue receipt or business receipt because NCDs were not issued in the course of regular business of the assessee as evident from the facts of the case.

Assessee’s main business is of cement and it was in the process of set up of cement manufacturing plant at Satna during the impugned assessment year. In these circumstances, we are constrained to hold that the amount received by the assessee in lieu of issuance of NCDs which were forfeited later on account of non-payment of call money assumes a character of capital receipt which earlier was shown as a loan liability in the books of account of the assessee. If we consider this receipt to be a business receipts even then it would not be taxable to tax under the provisions of section 41(1) of the Act, inasmuch as there was no allowance or deduction of this liability in the earlier years. We also do not find any provision in this Act according to which this type of receipts are chargeable to tax. We, therefore, are of the considered view that the revenue was not justified in treating this receipt as revenue receipt. We therefore, set aside the order of CIT(A) and delete the addition. In the result, the appeal of the assessee is allowed. This order is announced in the open court on this 23rd day of March, 2006.

Income Tax Law & High Court Judgments – Forfeiture       
Forfeiture of share application money gives rise to a short-term capital loss

The assessee company applied for allotment of shares in a public issue and paid share-application money. A proportionate allotment was done and the assessee was called upon to pay the balance sum. The Company failed to remit the balance allotment money, due to which the share-application money was forfeited. The assessee’s claim of short-term capital loss on account of the forfeiture of the share application money was rejected by the AO and the CIT (A). The ITAT allowed the claim of the assessee against which the Department filed an appeal to the HC.         

The HC held that consequent to the assessee’s default in not paying the balance money on allotment, its right in the shares stood extinguished on account of the forfeiture. The HC also held that the loss suffered by the assessee on account of non-recovery of share
application money, consequent to the forfeiture of its rights in the shares, was within the scope and ambit of transfer and hence the ITAT was justified in holding that it would amount to short-term capital loss to the assessee. 

DCIT v. BPL Sanyo Finance Ltd. 312 ITR 63 (Kar) Loan to subsidiary company written off is not an allowable expenditure. The assessee company, solely engaged in the business of mining, gave a loan to its wholly owned subsidiary, also engaged in the same business, for the purpose of constructing a jetty. In the following years, the subsidiary company suffered heavy losses and was not in a position to repay the loan. In the relevant assessment year, the assessee accepted a sum of money as full and final settlement of the loan and the balance amount was written off. The assessee claimed a deduction for the said sum on the ground that the loss was incidental to its business, which claim was rejected by the AO and confirmed by the CIT(A) and the ITAT. The HC observed that there were concurrent findings given by the lower authorities that the assessee was not  into the business of money lending and that the money was lent to the subsidiary company to construct a jetty which was a capital asset of the subsidiary company.

Hence, the HC agreed with the conclusion of the lower authorities that the loan granted did not spring directly from the business of the assessee company nor was it  incidental to it. Salem Magnesite (P) Ltd. v. CIT, 180 Taxman 545 (Bom)        

In more than one decision forfeiture of share application/call money is held as a capital receipt. The Mumbai bench of ITAT in dept appeal in Deputy Commissioner of Income-tax Vs. Deepak Fertilizers and Petrochemicals Corporation Ltd (304ITR AT 367) held that the amounts forfeited due to non-payment of call money could not be charged to tax. In this case the assessee had issued partly convertible debentures against which it received application money. However, after the allotment the applicants could not make the payments as per the terms of the issued debentures.          

The Ahmedabad bench of ITAT in Deputy Commissioner of Income-tax Vs. Brijlaxmi Leasing and Finance Ltd. (309ITR AT 211) held that the share application which had been forfeited as per the terms of the prospectus could not be treated as a receipt in the normal course of the business of the assessee, which was engaged in financing and leasing business. In this case too the assessee had not credited the forfeited amount in its profit and loss account but had credited the amount to capital reserve account. The Mumbai bench of ITAT in Prism Cement Ltd. Vs. Joint Commissioner of Income-tax (285ITR AT 43/101ITD103) held that the amount received by the assessee in lieu of issuance of debentures which were forfeited later on account of non-payment of call money would assume the character of a capital receipt which was shown earlier as a loan liability in the books of account of the assessee.        

The Mumbai bench in Jaikishan Dadlani v. ITO (4SOT138) held that there is no, and there cannot be any, dispute about the position that the share capital forfeiture receipts are in the nature of capital receipts. More so the Tribunal held that share forfeiture account is also not available for distribution of dividend hence any lending of money out of such account would not be treated as deemed dividend either.        

Companies Act & Legal Pronouncements – Forfeiture          
* The shares can be forfeited only of non-payment of calls and not for any other debt due from a member. Non-payment of calls is not the only reason for which shares can be forfeited; a company by its articles may provide for other grounds also. [Naresh Chandra Sanyal v Calcutta Stock Exchange Association Ltd. (1971) 41 Comp Cas 51 (SC)].      

* Shares of the shareholders who were running business of the company, cannot be forfeited for losses suffered by company. [Dilbhajan Singh v New Samundri Transport Co. (P) Ltd. (1985) 58 Comp Cas 247 (P&H)].

* CLB (now Tribunal) cannot direct forfeiture of shares acquired in  violation of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations. [Aska Investments (P) Ltd. v Grob Tea Co. Ltd. (2005) 61 SCL 134 (Cal)]. 

* Forfeiture will be affected by means of a Board resolution. Notice  precedent to forfeiture must be given to the defaulting shareholder. In the matter of forfeiture of shares, technicalities must be strictly observed. "The defect in the notice, though slight, invalidates it and is fatal to the forfeiture", as held by the Supreme Court in Public Passengers Service Ltd. v Khadar AIR 1966 SC 439. 

* In Sulochana Nathany v Hindustan Malleables & Forgings Ltd. (2001) CLC 448 (CLB), it was held that to constitute a valid forfeiture articles should give such powers to the directors. There should be notice of forfeiture and power should be exercised following the procedure prescribed in the articles.

* Further, articles generally provide that after the shares have been forfeited, an intimation is sent to the shareholder concerned and for sufficient reasons, the forfeiture may be annulled at the discretion of the Board of directors.Whether High Court has jurisdiction to entertain a shareholder's application questioning the action of company?
There is no provision in the Companies Act enabling the High Court to entertain an application relating to forfeiture of shares. [Tej Prakash Dangi v Coramandal Pharmaceuticals Ltd. (2001) 43 CLA 21 (AP)]. 

* The forfeiture must be bona fide and in the interest of a company. The power of forfeiture must be exercised bona fide and in the interest of the company. It should not be collusive or fraudulent. In Re. Esparto Trading Co. (1879) 12 Ch. D. 791, the forfeiture of shares was set aside, because it was found to have been carried out at the request of a shareholder to relieve him of liability. Such a forfeiture amounts to an abuse of power to forfeit and a fraud on other shareholders.    

* The Board may cancel the forfeiture of shares. In case defaulting shareholder approaches after forfeiture to cancel the forfeiture, the Board has been empowered to cancel such a forfeiture and claim due amount with interest.A forfeiture solemnly resolved upon and enforced for a long time, should not be set aside, nor can ex-member be reinstated without his consent. [Dhunraj Keshrimal v N. H. Wadia (1933) 57 ILR Bom 413].

* Once forfeiture has been enforced, the contract between the company and the member comes to an end; there can be no subsequent recession of forfeiture without the shareholder's consent. [Exchange Trust Ltd., In re (1903) 1 Ch. 711].        

* If shares were forfeited for non-payment of a call which was invalid, the company could withdraw forfeiture and issue a fresh call. [Bhagirath Spg. & Wvg. Co. Ltd. v Balaji Bhavani Power AIR 1930 Bom. 267].    

* Mere waiver, acquiescence or laches does not disentitle a shareholder from challenging forfeiture. [Sha Mulchand & Co. v Jawahar Mills Ltd. (1953) 23 Comp Cas 1 (SC)].

Original shareholders shall be liable for unpaid calls  

* In case of re-issue / disposal of forfeited shares, no allotment return to be filed. According the Companies Act, 2013, a company is required to file a return of allotment of shares and not for-reissued of forfeited shares. Allotment is, appropriation of the previously un appropriated capital of the company, of a certain number of shares to certain person. Till such allotment, the shares do not exist as such. However, in the case of forfeited shares, they had already been allotteed and they had come into existence at the time of their allotment and their forfeiture is a proof of their existence. Therefore, no return of allotment is required to be filed with ROC by a company at the time of re-issue or disposal of forfeited shares. [Sri Gopal Jalan and Co. V. Calcutta Stock Exchange Association ( 1963) 33 Com. Case 862: AIR 1964 SC 250].     

* Provision for payment of call in installments can be made only by a resolution of Board. [East & West Insurance Co. Ltd. v Kamla Jayantilal Mehta (1956) 26 Comp Cas 313 (Bom)]       

Finance Bill 2014 & Forfeiture    
The Finance Bill, 2014 presented by Mr. Arun Jaitley has reversed the tax provisions and hence forth with effect from 1 April, 2014. The receipts from the forfeiture will be subject to tax as any other business income. With this the tax position stands clarified in unambiguous terms.

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Note: Information placed here in above is only for general perception. This may not reflect the latest status on law and may have changed in recent time. Please seek our professional opinion before applying the provision. Thanks.