Share Substitution on Amalgamation Involving Stock-in-Trade May be Taxable u/s 28 Subject to Realisability: Supreme Court [Read Judgement]

The Supreme court has clarified that receipt of shares of the amalgamated company in substitution of stock-in-trade can give rise to taxable business profits under Section 28 of Income Tax Act, 1961. However, the court said that it is subject to realisability.

Justice R. Mahadevan and Justice J.B. Pardiwala, while entertaining the batch of petitions filed by companies including M/s Jindal Equipment Leasing & Consultancy Services Ltd, observed that “the main issue is answered in favour of the Revenue, in principle holding that the receipt of shares of the amalgamated company in substitution of stock-in-trade can give rise to taxable business profits under Section 28.”

‘However, the actual application of this principle to the facts of the present case, including whether the shares received are freely realisable or otherwise subject to restrictions, or whether the shares are held only as investment, is a matter requiring factual determination’ said the court.

The assessees, investment companies belonging to the Jindal Group, held shares of Jindal Ferro Alloys Ltd. (JFAL) as part of promoter holdings.

These shares were shown as investments in the balance sheet but were treated by the tax authorities as stock-in-trade. With regards to amalgamation approved by the High Courts, JFAL merged into Jindal Strips Ltd. (JSL), and shareholders of JFAL were allotted shares of JSL in a fixed exchange ratio.

In their returns, the assessees claimed exemption under Section 47(vii), stating that the shares were capital assets and that no taxable transfer arose on amalgamation.

The Assessing Officer rejected the claim. The department held that the shares constituted stock-in-trade, denied Section 47(vii) exemption, and brought to tax the difference in value as business income under Section 28.

While the income tax appellate tribunal granted relief, the Delhi High Court remanded the matter, observing that if the shares were stock-in-trade, the substitution could be taxable as business income.

The supreme court heard the matter in depth. It went through the provisions of Amalgamation, Capital asset, Transfer, Profits and gains of business or profession, Capital gains and Transactions not regarded as transfer and said that “the scope of taxability on amalgamation depends on the nature of the shares held.”

According to the bench, the taxability should be made after considering tests that is whether the substitution of shares results in real commercial profits, having accrued or arisen in the course of business, so as to be chargeable as business income under Section 28. Apart from the realisability, the court also requires that the shares must be quantified.

“We thus hold that where the shares of an amalgamating company, held as stock-in-trade, are substituted by shares of the amalgamated company pursuant to a scheme of amalgamation, and such shares are realisable in money and capable of definite valuation, the substitution gives rise to taxable business income within the meaning of Section 28 of the I.T. Act. The charge under Section 28 is, however, attracted only upon the allotment of new shares” said the division bench.

The Court clarified that share substitution on amalgamation is not per se taxable, but can be taxed under Section 28 subject to factual determination of realisability and accrual of real income. Accordingly it remanded the matter back to the income tax appellate tribunal.