The proviso to Section 232(3) of the Companies Act, 2013 ("the Act") contains a prohibition that is absolute in its terms: a transferee company shall not, as a result of a compromise or arrangement, hold any shares in its own name or in the name of any trust, whether on its behalf or on behalf of any of its subsidiary or associate companies, and any such shares shall be cancelled or extinguished. The prohibition applies equally to schemes under Section 233.
The Governance Rationale
Treasury stock—shares held by a company in itself—was a contentious feature of the pre-2013 regime. Companies could not hold their own shares directly, but they held them through trusts, and those trusts exercised voting rights. The effect was to inflate promoter control without a corresponding increase in economic ownership. The Companies Bill that became the 2013 Act was intended to end this practice by banning treasury stock outright and requiring extinguishment.
The prohibition is not merely technical. It prevents the circularity of a company voting its own shares, the artificial enhancement of earnings per share through the elimination of shares from the denominator without a corresponding economic event, and the entrenchment of control that treasury stock facilitates.
The Extinguishment Mechanism
Where a scheme would otherwise result in the transferee company holding its own shares—typically where the transferor company holds shares in the transferee company and the transferee issues shares to the transferor's shareholders—the shares are not held; they are cancelled or extinguished. The cancellation reduces the transferee's issued share capital, and the accounting treatment must reflect the extinguishment.
The extinguishment is not a reduction of capital under Section 66. It is a statutory consequence of the scheme, and it operates by force of the proviso. The auditor's certificate under Section 232(3) must address the extinguishment and the resulting capital structure.
The Drafting and Compliance Consequences
A scheme that does not provide for the extinguishment of the transferee's own shares is a scheme that contravenes the proviso. The NCLT may refuse to sanction the scheme, or it may direct the company to amend the scheme to provide for extinguishment. The company must ensure that the post-scheme shareholding pattern, the authorised capital, and the accounting entries are consistent with the extinguishment.
The prohibition is one of the few provisions in the scheme regime that operates automatically, without the need for a separate application or approval. A company that ignores it does so at the risk of the sanction itself.
Call to Action
Anuj Desai & Associates advises companies on the treasury stock prohibition—from the identification of cross-holdings and trust holdings in a scheme to the drafting of extinguishment clauses and the accounting treatment of the cancelled shares. If your scheme involves a transferor company that holds shares in the transferee, we can help you structure the extinguishment correctly.
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