Jupiter Capital – Why it matters that the Supreme Court ignored its own precedent (and some loss planning nuance)

In a recent post[1], I outlined three points of interest concerning the Supreme Court’s decision in Pr. Comm’r v Jupiter Capital[2] on the tax treatment of pro-rata capital reductions. Since then, I’ve uncovered some additional nuances that I believe are worth exploring. Let me take you through them.

The Priority Rule in G. Narasimhan[3]

Why do I think that the court's form driven approach, and its application of precedent delivered in the context of a reduction of preference share capital to a case involving a pro-rata reduction of equity share capital, is perplexing?

Imagine a scenario where the company undertaking the capital reduction is profitable. In that case, a pro rata reduction of equity share capital could very plausibly constitute a distribution to which S.2(22)(d) of the Income Tax Act applies. Under the priority rule in G. Narasimhan, the distribution would be treated as a dividend (to the extent of accumulated profit), a return of capital (to the extent of a shareholder’s cost basis in the shares reduced), and capital gain, in that order of priority. This priority rule would apply notwithstanding the fact that the reduction results in the transfer of a capital asset (i.e., the shares) by the shareholder.[4]

But what happens to a shareholder’s cost basis in the shares reduced (i.e., cancelled) if the entirety of the reduction proceeds is attributable to accumulated profit? The Supreme Court in G. Narasimhan did not address this scenario. And the Income Tax Act provides no answer.

In my view, the shareholder’s cost basis in the reduced shares should ‘hop’ to his remaining shares. After all, if a shareholder’s cost basis in his originally acquired shares can be ‘spread’ over his newly received bonus shares[5], why shouldn’t the reverse be true?[6] Of course, absent legislation that provides otherwise, a shareholder who is redeemed entirely may be out of luck, and his cost basis may simply ‘vanish’ – though if the recent amendment to S.46A of the ITA is anything to go by, recognizing a capital loss may not be entirely off the cards.[7]

Having said all that, if (as appears to be the case in Jupiter Capital, though it’s far from clear) the company is loss-making with no accumulated profit, the shareholder would presumably recognize a capital loss equivalent to the difference between the reduction proceeds and his cost basis. This is true regardless of whether we apply the priority rule in G. Narasimhan or skip it and simply treat the reduction as a transfer eligible for capital gains treatment.

Muddying the waters?

While the outcome in Jupter Capital would remain the same, how we get there matters and, regrettably, this is where the court fails to adequately explain its rationale for (1) extending the application of its precedent in the context of a reduction of preference shares to a pro rata reduction of equity shares as a transfer, and (2) not considering its own precedent in G. Narasimhan.

This isn’t entirely academic. Imagine again a scenario involving a profitable company with two shareholders who acquired their respective equity shares at different price points. The company undertakes a pro rata reduction of equity capital for an amount per share that translates into a gain for one shareholder and a loss for the other. The reduction proceeds are well represented by the company’s accumulated profit.

Under the priority rule in G. Narasimhan, the proceeds paid to both shareholders will receive dividend treatment under Section 2(22)(d). In contrast, under the rule in Jupiter Capital, a shareholder who bought shares for more than the reduction amount recognizes a capital loss. Two dramatically different outcomes.

Now, I may be slightly exaggerating the impact of the ruling in Jupiter Capital. It is true that the scenario the court dealt with involved a company with no accumulated profits. However, the primary function of the highest court in the land is to offer certainty, and by failing to consider and explain its own (binding) precedent, the court leaves room for dispute in situations of the kind I described above.

It’s worth noting that the precedents[8] the court relies on were decided by two-judge benches, whereas G. Narasimhan, a three-judge bench, holds greater precedential weight.

Potential Loss Planning in M&A: Some nuance

In my earlier post, I noted how Jupiter Capital could enable loss planning in M&A transactions. Upon closer examination, there’s an additional angle: Section 47(iii) of the Income Tax Act.

Per the Supreme Court’s decision in Comm’r v. Hariprasad[9], losses cannot be set off if the income from the same source is exempt. Under Section 47(iii), no transfer arises if a wholly owned subsidiary’s shares are transferred to its parent company (or nominees). If this rule applies, the capital reduction in Jupiter Capital would not generate a capital loss for tax purposes.

Curiously, the Supreme Court did not address this, even though Jupiter Capital held 99.88% of the subsidiary’s shares at the time of reduction. Under Indian corporate law, a private company must have at least two shareholders. If the remaining 12 shares were held by nominees of Jupiter Capital, Section 47(iii) might apply, barring the loss.

More importantly, companies could plan around this oversight. By transferring a nominal number of shares to a related or unrelated party, a company could fall outside Section 47(iii) and claim the losses.

I’ll save the GAAR implications for another time. ;)

A reminder that this isn’t legal advice.

[1] Read it here: https://www.linkedin.com/posts/joachim-saldanha_jupitercapital-tax-taxlaw-activity-7283325388489908225-d5jZ?utm_source=share&utm_medium=member_desktop

[2] SLP No. 63 of 2025

[3] [1999] 102 Taxman 66 (SC)

[4] “Therefore, any distribution which is made by a company on a reduction of its share capital which can be correlated with the company's accumulated profits (whether capitalised or not), will be dividend in the hands of the assessee. Therefore, it will have to be treated as income of the assessee and taxed accordingly… It is only when any distribution is made which is over and above the accumulated profits of the company (capitalised or otherwise) that the question of a capital receipt in the hands of a shareholder, arises.”

[5] Comm’r v Dalmia Investment, 52 ITR 567

[6] S.55(2)(aa) of the Income Tax Act has since overruled the rule in Dalmia Investment, but the principal remains sound.

[7] See my other writing on Section 46A here: https://www.linkedin.com/pulse/why-indias-new-buyback-tax-rule-might-simple-fix-save-saldanha-nyaje/?trackingId=%2BaV1gTOYQo7CQgPHRadlIw%3D%3D

[8] Anarkali Sarabhai v Comm’r, [1997] 11 SCL 121 (SC); Kartikeya Sarabhai v CIT, [1997] 14 SCL 73 (SC)

[9] [1975] 99 ITR 118 (SC)