Pursuant to announcement of merger of LVB with DBS India, many investors have been raising queries regarding the claim of loss on shareholding in LVB shares and whether under the tax laws, assessees are entitled to claim the loss in the current financial year and set it off against any capital gain on the sale of other assets. With the stock market booming, investors made huge gains by way of capital gains and if not attentive, they may end up paying tax (including advance tax) without setting off the eligible losses which they are otherwise entitled to. 

Against this backdrop, CA S. Ramanujam analyses the LVB-DBS amalgamation scheme while scrutinizing as to when the loss actually crystallises so as to enable the assessee to claim it as a deduction. The author highlights steps taken by the Govt. and RBI to protect the investors’ / depositors’ interests to rescue companies/financial institutions that went into financial crisis. Talking specifically about the LVB crisis, the author inter alia points out an interesting clause under the amalgamation scheme notified by the Finance Ministry, which specifies that all the share capital and reserves & surplus of LVB are written off as on November 27, 2020 and all the value of shares became nil. 

Analyzing the relevant provisions of the Income Tax Act and case laws explaining the applicability of ‘extinguishment’, the author observes that an extinguishment has occurred in LVB’s shares. The author opines that the ultimate outcome in this case even when, in the most unlikely scenario, a compensation is ordered by Courts to all shareholders may not affect the present claim, based on the RBI notifications, one can claim the loss which can be carried forward if there are no matching capital gains to set off. In conclusion, the author remarks that “One can end up by saying—the law needs to gallop too, along with the new solutions offered to tackle bigger scams; both should move hand in hand!”

LOSS OF SHAREHOLDING IN LAKSHMI VILAS BANK (LVB)—WHETHER CAPITAL LOSS?

INTRODUCTION:

One of the frequent queries received by the author in the recent days is regarding the claim of loss on the shareholding in LVB shares and whether under the tax laws, the assesses are entitled to claim the loss in the current financial year and set it off against any capital gain on the sale of other assets.  With the stock market booming, many investors made huge gains by way of capital gains and if not attentive, they may end up paying tax (including advance tax) without setting off the eligible losses which they are otherwise entitled to.  In the last few years, many investors lost money in other companies / banks as well—like YES Bank—tier 2 Bonds, ILFS—Preference Shares, Debentures in Dewan Housing and so on.  There was also a liquidity crisis in Franklin Templeton MF schemes—which has now repaid part of the redemption money to the unit holders in terms of the interim Orders of the Hon’ble Supreme Court.  The question that arises in all these cases is—when does the loss actually crystallise so as to enable the assessee to claim it as a deduction? Alternatively, if the loss is claimed, whether the same will be treated as notional or premature and hence not allowable? Though each of the instances of various financial instruments of different companies listed above have their own peculiar features, the case of LVB seems to be straight forward and one may be well advised to claim the loss in the current year itself on account of various measures taken by the Government.  This is analysed below.  

STEPS TAKEN BY GOVERNMENT TO PROTECT THE INVESTORS’ / DEPOSITORS‘ INTEREST:

On many occasions in the past, one has witnessed different methods used by RBI to rescue—either partly or fully—the companies / other institutions which went into huge financial crisis.  In the case of IL&FS group entities (financial liability outstanding estimated at Rs. 90,000 crores), the Board of Directors was superseded and a new Board was appointed to identify solutions to minimise the losses. Parallelly, NCLT was empowered by RBI to continue their proceedings—like reopening / recasting of audited accounts for the past 5 years etc.  In the case of YES Bank, SBI was asked to take over the majority shareholding by infusing additional capital, after enforcing a moratorium for a small length of time imposing limits of deposit withdrawals. In the case of IDBI bank, LIC was asked to infuse capital to the extent of Rs. 7,500 crores.  All these rescue measures, in many cases, had their own stings which affected many investors.  These being of recent history, they events are not discussed here again.  

LAKSHMI VILAS BANK—A BRIEF BACKGROUND TO THE PRESENT CRISIS AND RBI’S STEPS:

Started in the year 1926, in Karur, Tamil Nadu, this bank at the time of its collapse had roughly 3,500 employees and 566  branches.  After identifying the need to infuse additional capital, the bank tried many methods to rope in new investors but all these new investors were not approved by RBI.  The last AGM held in the year 2020 witnessed many unique things—accounts heavily qualified by the auditor, the auditor and many of the other promoter directors who stood for re—election not getting elected, etc.  At the time of its collapse, the shares of the Bank were traded at Rs. 7/- (nominal value Rs. 10/-). The market price of the shares fell from an all-time high of Rs. 97. 40 In April 2019 to the low of Rs. 16.40 in March 2020.  As per the Balance sheet as on 31^st March 2020, the share capital of the company stood at Rs. 336 crores, reserves and surplus at Rs. 893 crores and deposits at Rs. 21,443 crores.  The book value per share worked out to Rs. 16.07 / per share.  

In November 2020, the Government initially issued the following notification: (17^th Nov 2020):

“The rapidly deteriorating financial position of LVB relating to liquidity, capital, and other critical parameters and the absence of any credible plan for infusion of capital has necessitated Reserve Bank to take immediate action in the public interest and particularly in the interest of the depositors and accordingly, the Lakshmi Vilas Bank Limited was placed under moratorium by an order of the Government of India in the Ministry of Finance, Department of Financial Services vide number S. O. 4127(E), dated the 17th November 2020 in the exercise of the powers conferred by sub—section (2) of section 45 of the Banking Regulation Act, 1949 (10 of 1949),” the Finance Ministry notification said.

Subsequently, the RBI announced a merger scheme with DBS India Limited, a subsidiary of Asian Bank Limited, listed in Singapore.  The merger scheme became effective from 27^th November 2020 and the notification stated that all branches of LVB will function as branches of DBS with effect from that date. 

The scheme of amalgamation contained an interesting clause with regard to share capital & reserves and surplus of LVB.  This particular clause is extracted below:

Chapter—IV

Rights and liabilities of the members and creditors of the transferor bank:

(1) On and from the Appointed Date, the entire amount of the paid-up share capital and reserves and surplus, including the balances in the share/securities premium account of the transferor bank, shall stand written off.  

(2) On and from the Appointed Date, the transferor bank shall cease to exist by operation of the scheme, and its shares or debentures listed in any stock exchange shall stand delisted without any further action from the transferor bank, transferee bank or order from any authority“.

Many long term investors of the Bank as well as other large shareholders filed a writ petition challenging the RBI action in not giving them shareholding in DBS India Limited in terms of the amalgamation of LVB with DBS, as they expected the same to happen in the normal course.  On the other hand, the above clause 7 brought their hopes to nullity and they challenged the scheme before various High Courts and raised many contentious issues in their petition.  These cases are pending for final disposal.

One significant fact that emerges from the RBI notification of the merger Scheme is that all the share capital and reserves & surplus of LVB are written off as on 27^th Nov 2020 and all the value of shares became nil.  (There are other interesting clauses in the scheme as to how to value the assets, preparation of another Balance Sheet as on 27^th November 2020, which will be audited by another auditor appointed by RBI etc.  These aspects are not discussed here).

CLAIM OF LOSS ON SHARES—WHETHER ALLOWABLE IN THE FINANCIAL YEAR 2020—21 FOR THE SHAREHOLDERS OF LVB?

To examine this, one needs to know generally few sections dealing with the computation of capital gains.   Although these provisions are well known and there is no need to repeat the essence of these sections, few references are given—viz: definition of ”capital asset” u/s 2(24), the definition of Transfer—sec 2(47), the definition of long term / short term capital asset—sec 2(29A) Sec 2(42A) and the definition of corresponding terms—such as long term capital gain—sec 2 (29B) and short term capital gain—Sec 2 (42B) and also sec 74 allowing the carry forward and set off of capital losses, etc.  

The foremost issue to be looked into is: given that shares are capital assets, whether any transfer has occurred during the relevant financial year, especially due to the scheme of merger notified by RBI which has already taken effect from 27^th November 2020? Whether the definitioin of ‘transfer “ is satisfied here? The definition u/s 2(47) is reproduced to the extent needed for the present discussion:

Sec 2(47)—“transfer “in relation to a capital asset, includes –

(i) sale, exchange, or relinquishment of the asset ; or

(ii) extinguishment of any rights therein ; or ……. ”

(iii) ….

Explanation 2: For the removal of doubts, it is hereby clarified that “transfer“ includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company or registered or incorporated outside India.  

Note: This explanation though inserted in the aftermath of the Vodafone judgment with retrospective effect from 1st April 1962, a plain reading-with so many alternative cases covered-like "…parting with an asset…voluntarily or involuntarily" also can cover the present plight of the shareholders of LVB.   

Each of these terms extracted from the above definition are interpreted many times by the various courts.  If one applies the present facts to this definition, the nearest term that can be applied—is whether this could be termed as “extinguishment“ of rights in the shares in view of clause 7 of Chapter IV of the Scheme?

Some important case laws explaining the applicability of `extinguishment’ in certain instances:

1. CIT v Mrs. Grace Collis— [TS-5-SC-2001-O]—in the case of amalgamation, there is a transfer, as the shares of the transferor company are extinguished upon amalgamation.

2. The words—“extinguishment of rights therein” postulates continuous existence of the asset at the time of transfer; on the other hand, when an asset is destroyed, though a capital loss occurs, it is not on account of transfer as defined under the Act. [TS-3-SC-1991-O] and [TS-5018-SC-1997-O]

3. Giving up right to “specific performance“ amounts to extinguishment—[TS-7-HC-2005(MP)-O]

4. Reduction of share capital is a transfer as paying off shareholders would result in proportionate extinguishment of rights in the shares. [TS-24-SC-1997-O]; [TS-5067-SC-1998-O]

5. Redemption of preference shares is transfer—[TS-1-SC-1997-O]

6. Forfeiture of convertible warrants—there is extinguishment—[TS-5063-HC-2010(DELHI)-O]

Thus one can easily conclude that an extinguishment has occurred in LVB’s shares. 

The other issues regarding the applicability of Sec 45—viz. transfer of a capital asset effected during the previous year is also evident from the RBI’s notification on amalgamation and the running of branches as DBS bank.  In the opinion of the author, the ultimate outcome in this case even when, in the most unlikely scenario, a compensation is ordered by Courts to all shareholders may not affect the present claim, as today, based on the RBI notifications, one can claim the loss which can be carried forward if there are no matching capital gains to set off.

CONCLUSION: This analysis brings to light the other cases—preference shares of IL&FS, or the debentures of Dewan Housing, which are irretrievably lost(?).  When these losses should be claimed is an analysis that needs more closer examination.   One is also reminded of the words used in the explanation under sec 2(47) extracted above—whether parting of interest in the shares have occurred, though involuntarily in these cases is a question that needs to be looked at.  The question is—when there is no trading of a listed security consequent to the action by the regulators (on account of the  mismanagement of the company ‘s affairs) forcing in the total suspension of trading, whether a capital loss can be claimed, by claiming the value at Rs. NIL?? Few years ago, a suggestion to this effect was made to the government to allow the losses by reckoning certain notified securities to have attained Nil value as (deemed?) consideration for capital gains purposes in terms of Section 45. However no decision is taken yet on this.

One can end up by saying—the law needs to gallop too, along with the new solutions offered to tackle bigger scams; both should move hand in hand!