Receipt of amalgamated company’s shares in lieu of shares held as ‘stock-in-trade’ is realization of income (Delhi High Court)

The Delhi High Court (HC) in a recent decision in the case of Commissioner Of Income Tax vs M/S Nalwa Investment Ltd has examined an important question-whether any income accrues to a shareholders (holding such shares as ‘stock in trade’) upon receipt of shares of the amalgamated company in lieu of shares held in the amalgamating company. In the lower appellate proceedings, the Income Tax Appellate Tribunal (ITAT), had taken a view that no profit accrues unless the shares held are either sold or transferred otherwise for consideration, irrespective of the nature of holding (i.e. whether held as ‘investment’ or ‘stock-in-trade’). In other words, the ITAT held that no taxable event arose on receipt of share in the amalgamated company and hence it would not matter whether such shares are held as ‘investment’ or ‘stock in trade’ without going into the issue of characterization of shares. Impliedly, event of taxability was co-related to the transfer of shares of the amalgamated company.

The conclusion drawn by the ITAT was regarded erroneous by the HC considering the law settled by the Supreme Court (SC) in the case of Grace Collis. The SC in the matter has ruled that upon amalgamation, the shares held by the shareholders of amalgamating company are ‘extinguished’ and covered under the scope of ‘transfer’ u/s 2(14) of the Income Tax Act, 1961 for the purpose of capital gain [though exempted u/s 47(vii)].

However, the important debate of relevance that arose in the matter was whether any income would arise if the shares were held as ‘stock in trade’ (i.e. not as capital asset and thus outside the scope of capital gain.). It was argued by the assesses that if the shares are held as stock-in-trade, the receipt of shares of the amalgamated company could not lead to income in the hands of assessee since there can be no addition of any notional accretion/notional profit under the head ‘profit and gain of business or profession’ u/s 28 of the Act. Only profit on realisation of stock- in-trade by way of sale can be brought to tax under that head.

The HC accepted the basic proposition that no notional gains can be taxes in case of ‘stock-in-trade’. However, the HC observed that in the instant case, the assessee had received shares of amalgamated company in lieu of amalgamating company, the new shares did not represent the same stock in the inventory of the assesses and such shares would be valued entirely on different fundamentals. Further, under the scheme of amalgamation, the dissenting shareholders receive the value of their shareholding while the approving shareholders receive the same value in the form of shares of the amalgamated company and taxation principles would apply equally irrespective of the status of the shareholder. Accordingly, upon receipt of new shares (against shares in amalgamating company), there was actual realization of income and not notional accretion/profit. In arriving at the conclusion, the HC drew support from the decision of the SC in the case of Orient Trading Co. Ltd., (which was in context of exchange of shares) and certain English case laws on the subject referred to by the SC.

In conclusion, the HC has opined on an important principle of taxation relating to extinguishment of shares held as ‘stock in trade’ consequent to amalgamation. While the principle that no income arises by mere holding of inventory on account of notional gains is well established, however, extinguishment of shares and receipt of new shares in lieu thereof would be a case of ‘actual realization’ of income and not ‘notional income’ as clarified by the HC.  The ruling bears significance for taxpayers engaged in the business of stock trading who receive shares in a scheme of amalgamation in lieu of shares held in amalgamating company prompting a review of the tax position.

Contributed by Yatin Sharma. Views are personal.

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