1.1 The issue of applicability of capital gains tax on shares issued in the amalgamating company pursuant to amalgamation was the subject matter in CIT v. Nalwa Investment Ltd ITA [equivalent citation MANU/DE/1527/2020].
1.2 Nalwa Investment Limited (NIL) held shares of Jindal Ferro Alloy Ltd (JFAL) and pursuant to an amalgamation scheme sanctioned under section 391 to 394 of the Companies Act, 1956 (Companies Act), JFAL was amalgamated with Jindal Strips Ltd. (JSL). Consequently, NIL received shares of JSL in lieu of shares in JFAL and claimed exemption from capital gains tax under section 47(vii) of the Income Tax Act, 1961 (IT Act).
1.3 The Assessing Officer (AO) applied tax on the difference between the market value of JSL shares and the book value of the shares held in JFAL as business income on the basis that the NIL was holding the shares of JFAL as stock-in-trade and not as capital assets. The Commissioner of Income Tax (Appeals) upheld the decision of the AO.
1.4 Against the order of the Commissioner of Income Tax (Appeals), NIL preferred an appeal before the Delhi Bench of the Income Tax Appellate Tribunal (ITAT), which held that no profit accrued to NIL when shares of the amalgamated company are received in lieu of the shares of the amalgamating company and that the question regarding whether the shares were held as stock-in-trade or as capital asset was not relevant considering that the amalgamated company’s shares were not sold or otherwise transferred for consideration.
- Decision of the Hon’ble Delhi High Court
2.1 The issue in question before the Delhi High Court was whether ‘transfer’ took place upon receipt of shares in the amalgamated company in lieu of shares in the amalgamating company.
2.2 The Delhi High Court in CIT v. Nalwa Investment Ltd held that the transfer of shares held as stock-in-trade, in the scheme of amalgamation would constitute a taxable event under the head ‘profits and gains from business and profession’.
2.3 In its judgement, the Delhi High Court rejected ITAT’s observations and held that the taxability of the transaction depends on the classification of shares, as receipt of amalgamated company’s shares in lieu of amalgamating company’s shares held as ‘stock-in-trade’ would be taxable as business income. Therefore, the Delhi High Court remanded the matter back to ITAT for adjudication on the factual dispute regarding classification of shares as ‘stock-in-trade’ or ‘capital assets’.
2.4 The Delhi High Court observed that shares of the amalgamating company can be said to have been ‘transferred’ for capital gains tax purpose on the basis of the following:
2.4.1 Even though section 47 of the IT Act exempts certain transfers from taxability under the head ‘capital gains’ (including shares held by shareholder of amalgamating company), it still considers it to be ‘transfer’ as such. Therefore, even to take benefit of the specific exemption under section 47(vii), the extinguishment of amalgamating company’s shares under an amalgamation, would have to be regarded as a ‘transfer’.
2.4.2 The Delhi High Court relied on the judgement of the Hon’ble Supreme Court in Grace Collis and Ors [ 248 ITR 323], wherein it was held that extinguishment of rights in the capital asset, being shares of the amalgamating company, amounts to ‘transfer’ of such shares.
2.4.3 The Delhi High Court observed that if the shares are considered to be held as capital asset, both NIL and the Income tax Authorities agreed that section 47(vii) of the IT Act would apply to NIL’s facts, and accordingly, there would be no capital gain tax in NIL’s hands.
2.5 The Delhi High Court observed that the shares of amalgamating company were held as ‘stock in trade’ on the basis of the following:
2.5.1 Section 47(vii) operates for the purpose of capital gains. There is no express exemption when shares of amalgamated company received against amalgamating company’s shares which are held as ‘stock-in-trade’.
2.5.2 Relying on the ratio laid down by the Supreme Court in Orient Trading Co. Ltd [(1997) 224 ITR 371], which dealt with exchange of shares held as stock-in-trade, the Delhi High Court held that receipt of shares of the amalgamated company in lieu of shares of amalgamating company, does not merely represent a notional accretion or notional profit, which has not been realized by NIL. It observed that the fair value of shares received has to be considered as realised by NIL.
2.5.3 It was observed by the Delhi High Court that when shares are held as stock-in-trade, the tax analysis is not restricted to the concept of ‘transfer’, rather on whether there is income chargeable to tax under the head ‘profits and gain of business or profession’. Further, it observed that the relevance of the concept of ‘extinguishment or transfer’ would not be lost altogether because the nature of the asset is ‘stock-in-trade’ because pursuant to amalgamation, shares in amalgamating company can be said to be getting extinguished and replaced by amalgamated company’s shares and this would be valued entirely on different basis.
3.1 The Delhi High Court decision is significant to taxpayers who hold shares as stock-in-trade as it changes the common notion that amalgamation under section 2(1B) read with section 47(vii) of the IT Act is tax-neutral for all concerned parties and therefore, conversion of stock-in-trade into a capital asset or the other way around would be taxable under the IT Act.
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