Capital Reduction Cannot Be Taxed as Buyback Under Section 115QA: ITAT Delhi Rules in Favour of Assessee

Overview

When a company cancels its shares, the transaction may take several legally distinct forms — capital reduction, buyback, or forfeiture, among others. Each of these carries a different tax treatment under the Income-tax Act, 1961. A critical question arises when the tax authority conflates two structurally distinct mechanisms and applies the wrong provision of law. The ITAT Delhi addressed precisely this issue in Seaview Developers Pvt. Ltd. v. DCIT, ITA Nos. 2621 & 2719/Del/2024, pronounced on 8 July 2026, holding that capital reduction cannot be recharacterized as buyback and subjected to tax under Section 115QA of the Income-tax Act, 1961.

Background of the Case

The assessee, Seaview Developers Pvt. Ltd., is engaged in real estate development within a Special Economic Zone (SEZ) in Noida, Uttar Pradesh. The assessee company undertook a capital reduction scheme under which 36,768 shares held by BREP India Office Holdings IV Pte. Ltd. (BREP IV) — a Singapore-incorporated entity and a tax resident of Singapore — were cancelled.

Upon cancellation, a sum of ₹4,74,98,74,080 was remitted to BREP IV. The tax treatment applied by the assessee on this amount was structured as follows:

Note: As per the assessee's computation, ₹1,36,74,90,634 was treated as deemed dividend under Section 2(22)(d) of the Income-tax Act, 1961, on which Dividend Distribution Tax (DDT) was duly paid. The residual amount yielded a short-term capital gain of ₹17,13,93,913, taxed in the hands of BREP IV.

The Assessing Officer, however, took a fundamentally different view. The department recharacterized the entire capital reduction scheme as a buyback of shares and invoked Section 115QA, which levies buyback distribution tax. Additionally, the department labelled the scheme a "colourable device" designed to facilitate tax evasion. This triggered the primary dispute before the tribunal — not merely the tax computation, but whether a capital reduction scheme can legally be treated as a buyback under the Income-tax Act, 1961.

Understanding Capital Reduction

Legal Framework

Capital reduction is a corporate restructuring mechanism by which a company reduces its paid-up share capital. Under the Companies Act, 1956, the scheme was governed by Sections 100 to 104, which required:

1. Proposal of the scheme in a general meeting or an extraordinary general meeting
2. High Court approval before any cancellation of shares is effected

Once the High Court grants approval, shares are directly extinguished — no purchase by the company from the shareholder takes place.

Tax Treatment Under Section 2(22)(d)

Section 2(22)(d) of the Income-tax Act, 1961 provides that when a company reduces its share capital and makes a payment to shareholders, the portion of that payment attributable to accumulated profits is treated as deemed dividend.

Illustrative Example:

Suppose a company had issued 600 equity shares at a face value of ₹10 each. After two years, it reduces its capital by cancelling 100 shares and pays ₹120 per share. If the accumulated profit per share is ₹90, then:

• ₹90 per share → Deemed dividend under Section 2(22)(d) → Liable to DDT under Section 115-O
• ₹30 per share → Capital return
  • ₹10 → Cost of acquisition
  • ₹20 → Taxable as capital gain

This framework makes capital reduction conceptually and computationally distinct from buyback.

Understanding Buyback of Shares

Evolution of Buyback Taxation in India