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This article has been written by Shwetha Shivaram pursuing the Diploma in General Corporate Practice: Transactions, Governance, and Disputes from LawSikho. The article has been edited by Smriti Katiyar (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 was holding shares of Jindal Ferro Alloy Ltd (JFAL) which subsequently got amalgamated with Jindal Strips Ltd. (‘JSL’). 

The assessee company was 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 initially claimed as exempt by the assessee company.

Accordingly, upon the assessee company getting a favourable order from the ITAT, the Department filed an appeal against the order to the Honourable Delhi High Court where the court remanded the case back to the Tribunal for fresh adjudication and ordered the appeal in favour of the Department. 

Background and facts

The jurisdictional assessing officer of the assessee company claimed this particular transaction is taxable under the Income Tax Act and subsequently calculated an amount towards the profit on such transfer of shares. Such profit was calculated by adopting the value of shares of JSL at the rate of Rs. 218 per share, calculated the profit on receipts of shares of JSL under the scheme of amalgamation at Rs. 5,31,28,579/-, and taxed the same as ‘business income.’

The assessing officer was of the opinion that since the assessee company was holding JFAL shares as stock-in-trade and not as a capital assets, it was not entitled to exemption under Section 47(vii) of the Act. The statutory first Appellate Authority [‘CIT(A)’] supported the action of AO treating the same as a Taxable Income and issued a favourable order for the Department. Upon receiving this order a further appeal was filed before the Income Tax Appellate Tribunal by the assessee company. Upon such filing the ITAT heard the learned counsel of both the parties and upon 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 accrues when shares of the amalgamated company are received in lieu of shares of amalgamating company.

Aggrieved with the aforesaid order, revenue i.e the Income Tax Authority filed the present appeals before the Honorable High Court of Delhi, thereby questioning the correctness of the order passed by the ITAT and raised 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, learned senior counsel on behalf of the respondent

  • The shares of the assessee company i.e. JFAL and/or JSL are held as part of the promoter holding
  • The assessee company had furnished non-disposal undertaking stating that It would not dispose of the shares held in JFAL,  to financial institution 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 23rd 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 question of law which was admitted by the honourable High Court in the present case was:

  • “Whether the ITAT was correct in holding 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 in lieu of shareholding in the amalgamating company constitutes a transfer?”
  • “Whether the difference between the market value of the shares received by the assessee-companies in exchange of the shares of JFAL and the book value of shares has to be treated as income of the assessee under Section 28  of the Income Tax Act?”

Court’s 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 lieu of amalgamation should not be treated as a transfer and no tax is leviable on the same.

  • At the first instance the court tried to interpret the definition of capital gains under Section 45 of IT Act and the exemption provided under Section 47(vii) of the Act
  • The court has observed that Section 47 starts with a non obstante clause which states that “nothing contained in Section 47” 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) 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 learned counsel 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 v. Rasiklal Maneklal
  2. Commissioner of Income-Tax v. Mrs. Grace Collis and Ors., 
  3. Chainrup Sampantram v. CIT,
  4. Orient Trading Co. Ltd. v. Commissioner of Income-Tax, 
  • Accordingly, it was noted that in  the case 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 into 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 old company i.e JFAL has been replaced with new 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 same value in the form of shares of the amalgamated company
  • The income generated from the transaction has to be charged to income tax as per provisions of law. The fundamental principle to be followed is that the basic substance for the transaction has to be separated from the form and the taxing statute has to be applied accordingly
  • The has observed from the decision of ITAT that there is no transfer in the scheme of amalgamation, the decision issued by the Tribunal is not in order and  the same is unsustainable in so far as capital asset is concerned and findings of the Tribunal are plainly erroneous
  • Accordingly, the matter has been remanded back to the ITAT since the initial facts that is 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. Instead has only sent back the case for fresh hearing before the Tribunal and to revisit the facts of the case and relevant provisions of law.

Analysis and impact of the judgment

The court has tried to analyse 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 result as a transfer and whether the income on such transfer would be taxed under the income tax provision.

The case has been remanded 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 ITAT will have to give another opportunity of being heard to the parties of the case and hear their plea 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 a business income and taxable under Section 28 or to be treated as income from capital gains and taxable under Section 45 or exempt under Section 47(vii).

Simultaneously, it is also required to decide whether the shares held by M/s Nalwa Investment Ltd currently are being exchanged for JSL shares to be treated as stock in trade or to be treated as an investment which is held for a longer-term. 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 is to be treated as taxable or exempt under the income tax law.


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