[Kashvi Singh and Abhilipsha Naik are 3rd year students at National Law University, Odisha]
Corporate amalgamations are a common tool for restructuring business groups, enabling consolidation, efficiency, and strategic realignment. A crucial determinant of the commercial viability of such mergers is their tax treatment, particularly in relation to share-for-share exchanges between the amalgamating and amalgamated companies.
Traditionally, Indian tax law viewed amalgamations as tax-neutral corporate reorganisations, premised on the understanding that a statutory substitution of shares does not, by itself, result in real income. This position found statutory recognition in section 47(vii) of the Income Tax Act, 1961 (“IT Act”), which exempted capital gains arising from share swaps in amalgamations where shares were held as capital assets.
However, the Supreme Court’s decision in Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II marks a significant departure from this understanding for shareholders holding shares as stock-in-trade. The Court held that the receipt of shares of the amalgamated company in substitution of stock-in-trade could give rise to taxable business income under section 28 of the IT Act even in the absence of an actual sale or cash realisation.
This post examines the implications of this shift in three stages. First, it traces the pre-existing legal position and the judicial uncertainty surrounding the taxability of share substitutions involving stock-in-trade. Second, it analyses the Supreme Court’s reasoning in Jindal Equipment, with particular focus on the three-part test laid down to determine when such substitutions are subject to taxation under section 28 of the IT Act. Finally, it evaluates the broader consequences of the ruling, highlighting both the clarity it brings and the doctrinal concerns it leaves unresolved.
Legal Position Prior to Jindal Equipment
Before the Supreme Court’s decision in this case, the tax treatment of shares held as stock-in-trade and those received in a court-approved amalgamation remained ambiguous. While sections 45 and 47(vii) of the IT Act clearly exempted capital asset share swaps, stock-in-trade fell outside this framework, and section 28 of the IT Act, despite its wide scope, contained no express deeming provision that taxed mere substitution.
In this vacuum, courts alternated between deferring taxation until actual realisation under the real income doctrine, as inCIT v. Nalwa Investment Ltd. and Rasiklal Maneklal (HUF) v. CIT, and treating in-kind substitution of stock-in-trade as an immediately taxable business profit, as in Orient Trading Co. v. CIT. Thus, judicial interpretations ultimately oscillated in the absence of statutory clarity.
The Supreme Court’s Ruling
It is against this backdrop of uncertainty that the Supreme Court, in the present case, stepped in to resolve the controversy. In this case, the Court held that the receipt of shares of the amalgamated company in substitution of shares held as stock-in-trade can give rise to taxable business income under section 28 of the IT Act, and such substitution does not qualify for exemption under section 47, which is confined to transfers of capital assets.
The Court laid down a three-tier test for determining when the substitution of stock-in-trade pursuant to an amalgamation would trigger taxation.
First, the Court examined whether there is a receipt or accrual of income. It clarified that business income may be received not only in money but also in kind. Where shares are held as stock-in-trade, the allotment of shares of the amalgamated company constitutes a receipt in kind, ordinarily occurring upon actual allotment. While the Court acknowledged that, in exceptional cases, rights under a sanctioned scheme may vest earlier and give rise to accrual, the general rule remains that income is recognised when the assessee is placed in possession of the substituted asset. What amalgamation affects, therefore, is not a sale or exchange in the strict legal sense, but a statutory substitution of one trading asset for another.
Second, the Court underscored that commercial realisability is indispensable. Mere receipt of shares does not attract section 28 of the IT Act unless the assessee obtains a benefit that is real, not illusory. The Court, based on the real income doctrine and precedents such as Kanchanganga Sea Foods, held that the assessee must have effective control over the asset and the ability to convert it into money’s worth. Amalgamation, by itself, does not amount to commercial realisation; it is only where the substituted shares are freely tradable and immediately capable of disposal that the transaction assumes the character of a business profit. Situations involving lock-in periods, closely held companies, or the absence of a market were cited as instances where no such realisation can be said to occur.
Third, the Court required that the profit must be capable of definite valuation. For income to be taxable, the old trading asset must cease to exist, and the new asset must possess a definite and determinable value. This reflects the settled principle that profits are crystallised only when the earlier position is closed, and the economic outcome can be measured with certainty. Unrealised or notional accretions embedded in stock-in-trade cannot be brought to tax unless they are translated into an asset of measurable money’s worth.
In essence, the Court held that section 28 applies only when all three conditions are satisfied:
(i) the old stock-in-trade is extinguished;
(ii) the substituted shares have a definite and ascertainable value; and
(iii) the assessee is immediately in a position to realise that value through disposal.
Analysis: Clarity and Continuing Concerns
While this case resolves the legal question of whether share substitutions held as stock-in-trade can be taxed under section 28, the reasoning adopted by the Court calls for closer examination. The judgment departs from a strict company law understanding of amalgamation and adopts a substance-based, tax-focused approach. Although this shift is grounded in the real income doctrine, it raises concerns about its consistency with corporate law, the risk of repetitive taxation, and the absence of parity between gains and losses.
Firstly, it raises tension between company law and the tax treatment of amalgamation. Under company law, an amalgamation takes effect by statutory vesting, not by sale or exchange. Assets and shares pass automatically by operation of law, without any voluntary commercial act by the taxpayer. Tax laws generally respect this legal character unless a statute clearly provides otherwise. However, the judgment treats the receipt of shares in an amalgamation as a commercial realisation for tax purposes, even though there is no express provision that overrides the company law character of an amalgamation. This approach creates a disconnect between corporate law and tax law, and raises concerns that the transaction has been judicially re-characterised without clear legislative authority.
Secondly, it raises concerns about double taxation. When an assessee is taxed on the increase in value of shares at the time they are received in a merger, that value is already treated as income. If the same shares are sold later and the higher value is not treated as the cost of acquisition, the same increase in value is taxed again. In effect, the gain is taxed once when the shares are allotted and again when they are actually sold. Therefore, unless the fair market value of the shares at the time of allotment is taken as the cost of acquisition, taxing notional gains results in unfair and repetitive taxation or double taxation.
Thirdly, it creates non-parity between gains and losses. A company’s balance sheet reflects its true financial position only after both profits and losses are analysed. Similarly, if taxation treats notional gains from a merger as a realisation of income, then notional losses arising from the same transaction may also be recognised. For example, if an unfavourable swap ratio or a decline in market prices causes the shares received in a merger to be worth less than the original holding, the assessee may be entitled to claim a business loss under section 28. Taxing gains while denying corresponding losses may be inconsistent and unfair, as it reflects procedural non-parity.
Conclusion
The Supreme Court’s ruling in Jindal Equipment decisively clarifies the tax treatment of amalgamations involving shares held as stock-in-trade. By excluding such substitutions from section 47 and testing them under section 28 of the IT Act through the lens of real commercial realisation, the Court has resolved a long-standing ambiguity in Indian tax law.
The three-part test laid down by the Court ensures that taxation arises only where there is a definite, realisable business gain, bringing Indian practice in line with global approaches that distinguish investors from traders. While some concerns remain, the judgment provides much-needed certainty and signals that statutory amalgamations will not shield genuine trading profits from tax.
– Kashvi Singh & Abhilipsha Naik