This article has been written by Shwetha Shivaram pursuing the Diploma in General Corporate Practice: Transactions, Governance and Disputes from LawSikho. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho). 

Introduction

M/s Nalwa Investment Ltd (hereinafter referred to as “Assessee”) belonged to Jindal Group of Companies and was one of its promoter companies. The Assessee Company had as part of its investment shares of Jindal Ferro Alloy Ltd (JFAL) which subsequently got amalgamated with one of its other Group company Jindal Strips Ltd. (‘JSL’).  The assessee company were allotted the shares of JSL in lieu of shares held for JFAL and accordingly, the profit on this particular transaction was charged to Income Tax by the Income Tax Authorities which was claimed as exempt by the assessee company during the time of filing their Income Tax Return in the year of this Transaction. The assessee company received a Favourable order from the ITAT against the appeal filed and subsequently, the Department filed an appeal against the order to the Honourable Delhi High Court where the court gave the judgement stating that it would refer the case Back to the Tribunal for fresh Adjudication and hearing and ordered the appeal in favour of the Department.

Background and facts

The Assessee company belonged to Jindal Group of Companies and was one of its promoter companies which had initially made few investments. The Assessee was holding shares of Jindal Ferro Alloy Ltd. (“JFAL”) as part of its Investment. Upon JFAL being amalgamated with JSL, vide an amalgamation scheme sanctioned under Section 391-394 of the Companies Act, 1956, JFAL got amalgamated with Jindal Strips Ltd. (“JSL”). Due to this amalgamation, the shares held of JFAL was cancelled and subsequently shares of JSL were issued. Accordingly, upon the amalgamation taking place, the assessee company transferred its existing shares held in JFAL against the receipt of shares of JSL. Such transfer of shares was for a non-monetary consideration and the shares were issued in lieu of the existing shareholding. Hence, the particular transaction was claimed as exempt under the provisions of Income Tax Act and the management decided the same is not covered under the capital gain taxation under Section 47(vii) of the Act. 

However, the Jurisdictional Assessing Officer of the Assessee Company claimed this particular transaction as taxable under the Income Tax Act and subsequently calculated an amount towards the profit on such transfer of shares. The profit referred to by the Assessing officer was calculated by adopting a rate of Rs.218 per share as the value of JSL Share and accordingly the profit was calculated on receipt of shares of JSL Company under the scheme of amalgamation amounting to Rs. 5,31,28,579/-, and the same was taxed as ‘business income’ under the Income tax.

The assessing officer was of the opinion that since the assessee company was holding JFAL shares as stock-in-trade and not as capital asset, it was not entitled to exemption under Section 47(vii) of the Act. The Commissioner of Income Tax Appeals being the first Appellate Authority [‘CIT(A)’] gave the order in favour of the Department where it upheld the decision of the AO treating the transaction as Taxable Income. Upon receipt of this order from CIT(A) since the order was not in favour of the Assessee a further appeal was filed before the Income Tax Appellate Tribunal by the assessee company. Upon such filing of Appeal, the ITAT during the Hearing conducted took note of the arguments made by the learned counsel of both the parties and upon an analysing the facts of the case ITAT issued a favourable order towards the Assessee Company, thereby treating the entire transaction as not Transfer thereby not attracting tax under the provision of Income Tax Act. Accordingly, the appeal was allowed in favour of the Respondents, holding that no income accrue when shares of the amalgamated company are received in lieu of shares of amalgamating company. Aggrieved with the aforesaid order passed by the Tribunal, Revenue i.e the Income Tax Authority filed the present appeals before the Honourable High Court of Delhi, thereby questioning the correctness of the order passed by the ITAT and also raised concerns on several questions of law.  Accordingly, the High Court admitted the appeal and a substantial question of law was framed.

Facts argued by Mr. Ajay Vohra, Advocate arguing on behalf of the Respondent

• The shares of the assessee company i.e. FAL and/or JSL are held as part of the promoter holding.
• The assessee company had furnished a non-disposal undertaking stating that it would not dispose of the shares held in JFAL, to financial institutions and lenders who had lent money to the operating company.
• It was clear that Shares of JFAL were reflected as investment in Balance-Sheet of Financial Statement of the assessee company.
• The shares received in JSL on Amalgamation were not sold during the relevant previous year during which the Revenue had taxed this income and hence the income had not accrued during the relevant year during which it was taxed.
• The market price of the share of JSL as on 23^rd December 1996 was Rs.76/- per share whereas the assessing officer had adopted a rate of Rs.218/- per share.

Legal issues underlying the case law

The various question of law which was accepted by the honourable High Court in the present case was:

• Whether the Appellate Tribunal was right in treating that where the assessee gets shares of Amalgamated Company in lieu of shares of amalgamating company, no transfer takes place?
• Whether the assessees’ were holding the shares as ‘capital asset’ or ‘stock-in-trade’?
• Whether the respondent assessee is eligible to claim exemption under Section. 47(vii) or is the income from sale of shares taxable under Section 28.
• Whether the receipt of shares of amalgamated company against the shares held in the amalgamating company in lieu of amalgamation, constitutes a transfer?
• Whether the difference between the market value of the shares of JSL on the date of transfer, received by the assessee-companies against the shares of JFAL Company in lieu of amalgamation and the book value of shares of JFAL has to be treated as income of the assessed under Section 28 of the Income Tax Act.

Court observation and decision

The appeal has been filed by the revenue against the order issued by the ITAT in the favour of assessee stating that the issue of shares in JSL in lieu of amalgamation should not be treated as a transfer and no Income Tax is applicable on the same.

• At the first instance the court has tried to interpret the definition of capital gains under Section 45 of IT Act and the exemption provided under sec 47(vii) of the act
• The court has observed that sec 47 starts with a non obstante clause which states that “nothing contained in sec 45” which means that if the shares held as a capital asset and the subsequent exchange of shares in the course of amalgamation should not be treated as a transfer and hence exempt from capital gains taxation
• The definition of transfer as per Section  2(47) of the IT Act has been analysed where it has been noted that “Transfer takes with in its sweep the concept of sale, exchange or relinquishment of the asset as well as extinguishment of any right also a conversion of stock in trade into a capital asset would be treated as a transfer.
• It has been noted that the advocate arguing for revenue has agreed to the legal proposition and submits that if the shares were held as capital asset, the transfer would be exempt from the capital gains taxation referred under Section 47(vii) of the IT Act and ‘Revenue would have no case to argue before the Court of Law
• The court has noted the case laws of: 

1. Commissioner of income tax Bombay vs. Rasiklal Maneklal
2. Commissioner of Income-Tax v. Mrs. Grace Collis and Ors., 
3. Chainrup Sampantram vs. CIT, 
4. Orient Trading Co. Ltd. v. Commissioner of Income-Tax, 

• Accordingly, it was observed that in the case of Grace Collis and Ors., the scheme of amalgamation was virtually identical to the scheme that was in question in the Rasiklal Maneklal case. The Court went interpreted the expanded definition of ‘transfer’ under Section 2 (47) of the Act and extinguishment of rights of assessee in the capital asset, being shares in the amalgamating company, was held to be a ‘transfer’ within the meaning of Section 2(47). 

Thus, the judgment of Grace Collis and Ors has a direct bearing on the present case, and pertinently because the findings of the ITAT are solely resting on the decision in Rasiklal Maneklal case which has been considered and not followed in the later decision in Grace Collis and Ors.

• Subsequent to the process of amalgamation, the shares held in the earlier company i.e., JFAL has been replaced with fresh shares issued by the Amalgamated Company which is JSL the same would be valued entirely on different fundamentals.
• The non agreeing shareholders who do not support the amalgamation would receive an amount equivalent to the value of their existing shareholding while the shareholders approving this amalgamation would receive the consideration in the form of shares of the amalgamated company.
• The Income Tax has to be charged on the income obtained from the transaction as per provisions of Income tax Act. The basic principle to be followed is that the fundamental substance for the transaction has to be separated from the form and the taxing statute has to be applied accordingly
• The court has observed from the decision of ITAT that there is no transfer which can be considered as per Income Tax in this scheme of amalgamation, the decision issued by the Tribunal is not in order and the same is not sustainable as far as capital asset is concerned and findings of the Tribunal are plainly erroneous and unjustifiable.
• Accordingly, the matter has been remanded back to the ITAT since the initial facts which are under dispute between the parties has not been decided and appeals under this court were allowed in favour of the Revenue and against the assessee company.
• The court has not issued the order towards demanding any amount as liability towards this respective transaction. The court has only referred back the case to ITAT for a fresh hearing and to reconsider the facts of the case with all documentary evidence and relevant provisions of law.

Analysis and impact of the judgment

The court has tried to interpret the question framed by the revenue as to whether the scheme of amalgamation through which the shares of the amalgamated company received by the amalgamating company would be considered as a transfer and whether the income earned if any, on such transfer would be taxed as Income under the Income Tax provision.

The case has been referred back to the Income Tax Appellate Tribunal for a fresh adjudication process. However, even the High Court is of the opinion that the exemption under Section 47(vii) is not eligible for the Respondent Assessee and the Tax should be payable on the Transfer of shares.

Accordingly, the Appellate Tribunal will have to give another opportunity of being heard to both the parties of the case and hear their views based on the facts of the case and the matter to be decided accordingly keeping in mind all the findings of the Delhi High Court’s Order.

Conclusion

There are various ambiguities with respect to interpretation of the provisions under Income tax Law as to whether the particular transaction in relation to the exchange of shares with respect to the Amalgamation procedure should be treated as Income under the head of Business or Profession and whether the same is taxable under Section 28 or to be treated as Income from Capital Gains and taxable under Section 45 or exempt u/s 47(vii). Simultaneously, it is also required to decide whether the Shares of JFAL held by M/s Nalwa Investment Ltd are currently being exchanged for JSL Shares, to be treated as Stock in Trade or to be treated as a Current/ Non-Current investment which is held for a longer-term and not for immediate sale. Upon deciding on the above referred Terms it is to be decided and the order will have to be passed by the ITAT whether the transaction to be treated as Taxable or exempt under the Income Tax law.

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