Delhi High Court holds that receipt of amalgamated company’s shares under amalgamation against shares held as stock-in-trade is taxable as ‘business income’

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Shares of amalgamating company held as ‘capital assets’

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The Court observed that shares of the amalgamating company can be said to have been ‘transferred’ for capital gains tax purpose mainly for the following reasons:

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While 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 nonetheless 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’.

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The HC relied on the judgement of the Supreme Court (SC) in Grace Collis and Ors [2001] 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.

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Having said that, the Court noted that if the shares are considered to be held as capital asset, both the Taxpayer and the Income tax Authorities agreed that section 47(vii) of the IT Act would apply to the Taxpayer’s facts, and accordingly, there would be no capital gain tax in the Taxpayer’s hands.

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Shares of amalgamating company held as ‘stock-in-trade’

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The HC noted that unlike section 47(vii) which 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’.

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Relying on the ratio laid down by the SC in Orient Trading Co. Ltd (1997) 224 ITR 371 (which dealt with exchange of shares held as stock-in-trade),  the HC held that receipt of shares of the amalgamated company in lieu of shares of amalgamating company, does not merely represent a notional accretion / notional profit which has not been realized by the Taxpayer. The HC held that the fair value of shares received would need to be considered as realised by the Taxpayer.

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The HC observed that when shares are held as stock-in-trade, the tax analysis is not restricted to the concept of ‘transfer’, but instead on whether there is income chargeable to tax under the head ‘Profits and gain of business or profession’. Having said that, the HC also held that the concept of ‘extinguishment/transfer’ would not lose its relevance altogether because the nature of the asset is ‘stock-in-trade’. This is because, pursuant to amalgamation, shares in amalgamating company can be said to be getting extinguished and replaced by amalgamated company’s shares which would be valued entirely on different fundamentals.

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The HC also noted that under the Companies Act, the shareholders who dissent to the scheme of the amalgamation are given the option of receiving cash or equivalent as the price for the shares based on the exchange ratio. The process of amalgamation would apply equally from both legal and taxation viewpoint, irrespective of the status of the shareholder (ie whether the shareholder is a dissenting shareholder receiving ‘cash’ or an approving shareholder receiving shares of the amalgamated company).