Introduction.
The Companies Act 2013 and the previous enactments thereof, have allowed companies to incorporate themselves with a charitable objects like promotion of arts, culture, science, or social welfare etc. since these companies are regulated under section 8 of Companies Act 2013, they are popularly known as section 8 companies.
Because, the section 8 companies are formed for charitable purposes and they do not work for earning profits, the Companies Act 2013 (the Act) provides exemptions from certain compliances and also imposes restrictions with respect to certain matters, more specifically relating to outflow of money from the company. in this article, we shall try to deliberate upon existence of one such restriction, which relates to capital reduction by a section 8company.
Concept of capital reduction.
Section 66[i] of the Act allows the companies to undertake reduction of its paid-up capital after obtaining the permission of its shareholders and the National Company Law Tribunal (Tribunal). by the virtue of such capital reduction, the company reduces amount of its paid-up capital by cancelling some of the equity shares. the money taken from shareholders at the time of allotment of such cancelled shares is paid back to the shareholders in the form of money, resulting in to outflow of funds from the business.
As per section 66(1), there are 2 (two) methods through which, companies may undertake capital reduction. Under first method, company may extinguish or reduce the liability on shares where the value is not paid up. For example, if the face value of one share is Rs. 10 out of which Rs.7 is called and paid up, and Rs. 3 remaining uncalled and unpaid, the company can reduce face value to Rs. 7. This extinguishes Rs. 3 unpaid liability per share, meaning shareholders are no longer obligated to pay this amount, and the company cannot demand it. This results in an indirect reduction of funds the company could have received.
Under second method, the company may cancel or payoff the value of paid-up share capital which is more than its current needs. For example, if the face value of share is Rs 10 fully paid up, then the company can cancel this share from its paid-up capital. The corresponding RS.10 previously received at the time of allotment is returned to the shareholder. This results in a direct outflow of funds from the company to its shareholders.
In first method, the company waives off its right to receive Rs. 3 which it was authorised to receive as unpaid share capital resulting into indirect outflow of money. Whereas, in case of second method, the company pays out the whole amount of RS. 10 to the shareholders resulting into direct outflow of money.
Although all methods of capital reduction result in to outflow of funds or restrict receipt of unpaid share capital from the company, the point worth noting is that section 66 does not expressly barr capital reduction by any kind of company including section 8 company. The section uses the word “company” and does not bifurcate into public company, private company, producer company or section 8 company etc. and therefore allows all types of companies to undertake capital reduction After obtaining approval from the Tribunal.
Restrictions on section 8 company as per section 8 & allied rules thereof.
For any company having charitable objects being called as section 8 company, it is mandatory that such company obtains a licence under section 8 of the Act. This section imposes some restrictions on the company while granting such licence. These restrictions pertain to conversion of section 8 company into any other form or alteration of its memorandum of association etc. but the major restrictions pertain to restricting outflow of funds from the company.
2 out of 3 mandatory conditions prescribed under section 8(1) for obtaining licence state that,
- The profits and other income of the company should be used only for promoting its business.
- The section 8 company shall not pay any dividend to its members.
Other then this, in case of merger or winding up as well, of section 8 companies in ere are restrictions. Sub-sections 7 & 10 of section 8 specify that a section 8 company can merge only into another section 8 company having similar objects as that of the merging company. Also, in case of winding up, sub-section 9 of section 8 says that in the process of winding up of section 8 company, if there are any assets left after satisfying all the debts and liabilities, then such assets should either be transferred to other section 8 company having similar objects or should be sold and its proceeds should be deposited in to Insolvency and Bankruptcy fund.
Further, if reference is made to the format of licence granted by the Registrar of Companies to a section 8 company, it clearly enumerates certain clauses, subject to compliance of which, the licence is granted by the registrar. These conditions provide that, “the profits, if any or other income and property of the said company, whensoever derived, shall be applied solely for the promotion of the object as set forth in its memorandum of association and that no portion thereof shall be paid or transferred, directly or indirectly, by way of dividend, bonus, or otherwise by way of profit, to persons who at any time are or have been members of the said company or any of them or any person claiming through any one or more of them; no remuneration or other benefit in money or money’s worth shall be given by the company to any of its members.
All these provisions clearly highlight that; a section 8 company cannot spend any of its money for any purpose other then for its main object specified in its memorandum of association. More specifically, it cannot pay any money to its members through any direct or indirect method. However, the point worth noting is that, despite imposing so many restrictions, just like section 66, section 8 also does not provide for any express prohibition upon section 8 company from undertaking capital reduction.
Capital reduction resulting in to outflow of funds.
As discussed above, although section 8 and section 66 both do not prohibit capital reduction by section 8 company, section 8 does prohibit outflow of funds for reasons other than the objects of the company. More specifically if it is for benefit of shareholders. Whereas capital reduction by any company, results into direct or indirect outflow of funds.
Judicial pronouncement.
The above discussed view is supported by a judicial pronouncement made by National Company Law Tribunal Chennai bench in its judgment in the matter of: LBR Foundation India.[ii] in this case, LBR Foundation, a section 8 company had filed an application for allowing its capital reduction. The honourable Tribunal while dismissing the petition, highlighted that,
“32.29 As per Section 8(1)(b) of the Act, 2013, any profits or income received by the Company should be applied only for the purpose of promoting its objects. Further, Section 8(1)(c) of the Act, imposes a restriction on distribution of dividend. Even in the event of winding up or dissolution of a Company registered under Section 8, surplus assets have to be transferred to another company registered under Section 8 and having similar objects or be sold and proceeds thereof credited to Insolvency and Bankruptcy Fund formed under section 224 of the Insolvency and Bankruptcy Code, 2016. The object of such restrictions imposed by this provision is to ensure that there is transparency in the functioning of companies formed for charitable objects and to prevent the siphoning of funds in any capacity.
Any income, in this case foreign contribution, received by the Petitioner ought to be strictly applied towards promoting its objects and the Petitioner cannot escape from the same by returning the foreign contribution to the Overseas Parent Company under the guise of reduction of share capital money.
33. In view of the foregoing discussions, this Tribunal is of the view that it is not just and proper to allow the reduction of share capital of the Petitioner.”
Defeating the purpose.
As is evident from the language of section 8, the section 8 companies are formed for fulfilling charitable objects. Also, payment of dividend or profit in any way to shareholders is prohibited to facilitate maximum spending on such charitable objects. Further, the money invested by shareholders in a section 8 company is a kind of contribution to charitable objects undertaken by the section 8 company. and donations made for charitable objects are not expected to yield any financial returns. Considering all these things, if profit earned by a section 8 company is transferred to its shareholders in the name of capital reduction, then this would defeat the very purpose of forming a non-profit making company for undertaking charitable objects. This would result in to not just legal non-compliance but also defeating the purpose of section 8.
Conclusion
Combined reading of legal provisions and judicial pronouncements highlights the fact that, although no section expressly prohibits capital reduction by section 8 companies, by the virtue of restrictions imposed by section 8, it is not permissible for such companies to undertake capital reduction. If any section 8 company does undertake such reduction, then it would result in non-compliance with restrictions imposed by section 8.
[i] 66. (1) Subject to confirmation by the Tribunal on an application by the company, a company limited by shares or limited by guarantee and having a share capital may, by a special resolution, reduce the share capital in any manner and in, particular, may—
(a) extinguish or reduce the liability on any of its shares in respect of the share capital not paid-up; or
(b) either with or without extinguishing or reducing liability on any of its shares, —
(i) cancel any paid-up share capital which is lost or is unrepresented by available assets; or
(ii) pay off any paid-up share capital which is in excess of the wants of the company,
alter its memorandum by reducing the amount of its share capital and of its shares accordingly:
[ii] In the matter of: LBR Foundation India NCLT order dated 4th March 2025. CP(CA)/73(CHE)/2023
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