Supreme Court: Receipt Of Shares Of Amalgamated Company In Substitution Of Stock-In-Trade Can Give Rise To Taxable Business Profits U/S 28 Income Tax Act
The Supreme Court said that once the shares held as stock-in-trade in the amalgamating company ceases to exist and are replaced by shares of the amalgamated company of higher value, a business profit arises.
Justice J.B. Pardiwala, Justice R. Mahadevan, Supreme Court
The Supreme Court held 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 of the Income Tax Act, 1961 (ITA).
The Court held thus in a batch of Civil Appeals arising out of a common Judgment and final Order of the Delhi High Court, which remanded the matters to the Income Tax Appellate Tribunal (ITAT) for fresh adjudication on the question of whether the shares held in the amalgamating company constituted stock-in-trade or capital assets, upon observing that, if the shares were, in fact, held as stock-in-trade, the transaction would fall outside the purview of Section 47(vii) of ITA, and its taxability would consequently be governed by Section 28 under the head “profits and gains of business or profession”.
The two-Judge Bench comprising Justice J.B. Pardiwala and Justice R. Mahadevan observed, “Accordingly, 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. In these circumstances, the proper course is to remit the matter to the Tribunal for fresh adjudication in accordance with law.”
The Bench said 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 ITA.
Senior Advocates Ajay Vohra and Kavita Jha appeared on behalf of the Appellants, while Additional Solicitor General (ASG) Raghavendra P. Shankar appeared on behalf of the Respondents.
Brief Facts
The Appellants were investment companies of the Jindal Group and the shares of the operating companies, namely Jindal Ferro Alloys Limited (JFAL) and Jindal Strips Limited (JSL), were held as part of the promoter holding, representing controlling interest. The Appellants had also furnished non-disposal undertakings to the financial institutions/lenders who had advanced loans to the operating companies. These shares were reflected as investments in the balance sheets of the Appellants. During the previous year relevant to the assessment year 1997-98, pursuant to a scheme of amalgamation approved by Orders of the High Courts of Andhra Pradesh and Punjab & Haryana respectively, under Sections 391 – 394 of the Companies Act, 2013, JFAL was amalgamated with JSL. Under the scheme of amalgamation, the shareholders of JFAL were allotted 45 shares of JSL for every 100 shares of JFAL held by them.
Accordingly, the Appellants were allotted shares of JSL in lieu of the shares of JFAL. The Appellants, in their returns of income, claimed exemption under Section 47(vii) of ITA in respect of the receipt of JSL shares in lieu of JFAL shares, treating the same to be capital assets. However, in the assessment completed under Section 143(3) vide order, the Assessing Officer (AO) treated the shares of JFAL as stock-in trade, denied the exemption under Section 47(vii), and brought to tax the value of JSL shares as business income, computed with reference to their market value. The said order was upheld by the Commissioner of Income Tax (Appeals). On further Appeals, the Tribunal allowed the assessee’s Appeals and concluded that there was no transfer of shares and, consequently, no taxable profit could be said to have accrued to the Appellants. The Revenue challenged this before the High Court, which disposed of the Appeals in favour of Revenue and against the assessees. Being aggrieved, the Appellants approached the Apex Court.
Reasoning
The Supreme Court in view of the above facts, noted, “Merely because a specific substantial question of law was not framed, it cannot be concluded that prejudice was caused to the parties, if both parties had the opportunity to address the issues in dispute. … Accordingly, the High Court cannot be said to have exceeded its jurisdiction under Section 260A in making the impugned observation on Section 28 before remanding the matter. The preliminary contention of the appellants is, therefore, devoid of merit and stands rejected.”
The Court enunciated that in the absence of any analogous deeming provision in respect of amalgamations, Section 28 cannot be judicially expanded to cover hypothetical or unrealised gains.
“… once the shares held as stock-in-trade in the amalgamating company ceases to exist and are replaced by shares of the amalgamated company of higher value, a business profit arises which is liable to be taxed under Section 28. … It is well settled that charging provisions, while construed strictly, are not to be read in an unduly narrow manner when the language of the provision itself is wide”, it reiterated.
The Court remarked that Section 28 is a comprehensive charging provision designed to bring within the tax net all real profits and gains arising in the course of business, whether convertible into money or received in money or in kind, and irrespective of whether such accrual or receipt of income is accompanied by a legal transfer in the strict sense.
“It is settled law that income yielding business profits may be realised not only in money but also in kind. Thus, where an assessee receives shares of the amalgamated company in place of its shares held as trading stock, there is, in form, a receipt of consideration in kind. Though such amalgamations receive the sanction of the Court/Tribunal to be effectuated, they are preceded by decisions taken in meetings of shareholders”, it observed.
The Court said that where under a scheme of amalgamation the shareholder merely receives, in substitution, shares of the amalgamated company in lieu of the shares held in the amalgamating company, there is no real or completed profit capable of being taxed under Section 28, unless it is shown that the shares are held as stock-in-trade and are readily available for realisation.
“In the absence thereof, what takes place is only a statutory vesting and substitution of one form of holding for another. Unless and until the substituted shares are commercially realisable – whether saleable, tradeable, or by whatever other mode of disposition so described – so as to yield real income, no taxable event can be said to arise”, it added.
The Court further noted that profit must be capable of definite valuation, so that the real gain or loss stands crystallized and judicial decisions have consistently underscored that “profits”, in the commercial sense, are ascertainable only when the old position is closed and the new position is determined in terms of money’s worth – whether by sale, transfer, exchange, or statutory substitution.
“This principle is an application of the doctrine of real income and applies with equal force to stock-in-trade as it does to other forms of commercial receipts. Therefore, the test is not satisfied merely by the receipt of realisable shares in substitution of earlier holdings; such shares must also be capable of quantification”, it added.
The Court held that the profit arising on receipt of the amalgamated company’s shares may be taxed under Section 28 where the shares allotted are tradable and possess a definite market value, thereby conferring a presently realisable commercial advantage.
“This conclusion flows from the real income principle and not from any judicially created fiction. Equally, it must be emphasised that where such attributes are absent, the Court cannot, by analogy, extend Section 28 to tax hypothetical accretions in the absence of an express statutory mandate”, it emphasised.
The Court also observed that the charge under Section 28 is not attracted on the mere sanction of the scheme or on the appointed date, but only upon the receipt of the new shares, when the statutory substitution translates into a concrete, realisable commercial advantage.
“While the possibility of tax avoidance in the investment field cannot be ruled out altogether, the legislative judgment reflects that the risk is relatively low. The exemption under Section 47 is thus founded on the recognition that amalgamation, in the capital field, is essentially a corporate restructuring and not a true realisation of profit. It is also common in business parlance for entities to hold shares either as investments or as stock-in-trade”, it elucidated.
Conclusion
Moreover, the Court said that the substitution of one trading asset by another, such as the receipt of shares in an amalgamated company in lieu of shares held as stock in-trade in the amalgamating company, cannot be equated with a mere continuation of an investment and it represents a commercial realisation in kind, for the new shares are distinct assets with a definite and presently realisable market value.
“If amalgamations involving trading stock were insulated from tax by judicial interpretation, it would open a ready avenue for tax evasion. Enterprises could create shell entities, warehouse trading stock or unrealised profits therein, and then amalgamate so as to convert them into new shares without ever subjecting the commercial gain to tax. Equally, losses could be engineered and shifted across entities to depress taxable income. Unlike genuine investors who merely restructure their holdings, traders deal with stock-in-trade as part of their profit-making apparatus; to exempt them from charge at the point of substitution would undermine the integrity of the tax base”, it added.
The Court, therefore, concluded that the statutory substitution of shares of the amalgamating company by shares of the amalgamated company is not a mere neutral replacement; where the new shares are freely marketable and possess a definite commercial value, the event constitutes a commercial realisation giving rise to taxable business income.
Accordingly, the Apex Court disposed of the Appeals and affirmed the impugned Judgment.
Cause Title- M/s Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II, New Delhi (Neutral Citation: 2026 INSC 46)
Appearance:
Appellants: Senior Advocates Ajay Vohra, Kavita Jha, AOR Aniket Deepak Agrawal, Advocates Vaibhav Kulkarni, and Aabgina Chishti.
Respondents: ASG Raghavendra P. Shankar, AOR Raj Bahadur Yadav, Advocates Udai Khanna, Karan Lahiri, Vimla Sinha, Seema Bengani, Preeti Rani, and Digvijay Dam.
