The Supreme Court held that shares in an amalgamating company, when held as stock-in-trade, result in taxable business income under Section 28 of the Income Tax Act. Justices J.B. Pardiwala and R. Mahadevan dismissed appeals, holding Section 47(vii) inapplicable.
NEW DELHI: The Supreme Court held that If shares in the amalgamating company are held as stock-in-trade, receipt of shares in the amalgamated company gives rise to taxable business income under Section 28 of the Income Tax Act, 1961.
The bench of Justice J.B. Pardiwala and Justice R. Mahadevan dismissed the appeals and upheld the Delhi High Court’s judgment observing that Section 47(vii) has no application to stock-in-trade
The matter was remanded to the Tribunal to determine the nature of shareholding.
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Factual Background of the Case:
The appellants were investment companies belonging to the Jindal Group, holding substantial shares in operating companies, namely Jindal Ferro Alloys Limited (JFAL) and Jindal Strips Limited (JSL). These shareholdings formed part of the promoter’s controlling interest and were subject to non-disposal undertakings given to financial institutions.
During the Assessment Year 1997–98, JFAL was amalgamated with JSL under a scheme approved by the High Courts of Andhra Pradesh and Punjab & Haryana under Sections 391–394 of the Companies Act. Under the scheme:
- The appointed date of amalgamation was 1 April 1995
- The effective date was 22 November 1996
- Shareholders of JFAL were allotted 45 shares of JSL for every 100 shares of JFAL
The appellants, upon receiving shares of JSL, claimed exemption under Section 47(vii) of the Income Tax Act, asserting that the shares of JFAL were held as capital assets.
However, the Assessing Officer (AO) rejected this claim, holding that the shares of JFAL constituted stock-in-trade, not investments. Consequently, the AO treated the receipt of JSL shares as business income, taxable under Section 28, computed on the basis of market value. This view was upheld by the Commissioner of Income Tax (Appeals).
Income Tax Appellate Tribunal (ITAT) allowed the assessee’s appeals, holding that no income accrues unless shares are sold or transferred for consideration, irrespective of whether they are capital assets or stock-in-trade. The Tribunal relied on CIT v. Rasiklal Maneklal (HUF) to conclude that amalgamation does not amount to a “transfer”.
The Delhi High Court, on appeal by the Revenue, set aside the Tribunal’s decision.
It held that:
- If shares are capital assets, amalgamation constitutes a transfer but is exempt under Section 47(vii)
- If shares are stock-in-trade, receipt of amalgamated company shares amounts to realisation of trading assets, taxable under Section 28
- The High Court remanded the matter to the Tribunal to determine the nature of the shareholding
Aggrieved by the High Court’s reasoning, the assessees approached the Supreme Court.
Legal Issues Framed:
- Whether the High Court exceeded its jurisdiction under Section 260A by examining taxability under Section 28 without framing a specific substantial question of law.
- Whether receipt of shares on amalgamation, when original shares are held as stock-in-trade, gives rise to taxable business income.
- Whether actual sale or transfer is mandatory for taxation under Section 28.
- Whether such income is real or merely notional, taxable only upon subsequent sale of shares.
Arguments Of Parties:
The assessees contended that the High Court’s judgment was unsustainable for follwing reasons:
- Relying on Shiv Raj Gupta v. CIT, it was argued that the High Court could not decide issues not specifically framed as substantial questions of law. The taxability under Section 28 was neither framed nor argued at the admission stage. It leads to Jurisdictional Overreach under Section 260A
- It was argued that on amalgamation, the amalgamating company ceases to exist and its shares are extinguished. Since there is no subsisting property, there can be no exchange or sale. Reliance was placed on Rasiklal Maneklal (HUF) v. CIT, Vania Silk Mills Pvt. Ltd. v. CIT and CIT v. Motors & General Stores (P) Ltd.
- The definition of “transfer” under Section 2(47) of the IT Act is Irrelevant to Stock-in-Trade and it applies only to capital assets. For stock-in-trade, income arises only on actual realisation, i.e., sale.
- It was submitted that mere substitution of shares does not create a debt or enforceable right to receive income, and hence no income accrues. Reliance was placed on E.D. Sassoon & Co. Ltd. v. CIT , Shoorji Vallabhdas & Co, Excel Industries Ltd and Godhra Electricity Co. Ltd.
The Revenue strongly defended the High Court’s ruling:
- It was argued that Section 28 taxes profits and gains of business, irrespective of whether they arise by sale, exchange, or otherwise. Unlike Section 45, Section 28 does not require a “transfer”.
- Once shares held as stock-in-trade are substituted by shares of another company of ascertainable value, realisation occurs, giving rise to taxable business income. Reliance was placed on Orient Trading Co. Ltd. v. CIT, T.V. Sundaram Iyengar & Sons Ltd. and Meghalaya Steels Ltd.
- Relying on Hindustan Lever Ltd. v. State of Maharashtra, it was argued that amalgamation involves transfer of value and extinguishment of rights, amounting to a commercial realisation.
Analysis of the Court:
1. On High Court’s Jurisdiction under Section 260A
The Supreme Court rejected the assessee’s preliminary objection. It held that The issue of Section 28 taxability was incidental and integral to the main question and Parties had full opportunity to address the issue. Unlike Shiv Raj Gupta, no prejudice was caused.
It 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 relied on Mansarovar Commercial Pvt. Ltd. v. CIT to hold that incidental questions can be decided even if not expressly framed.
2. Distinction Between Capital Assets and Stock-in-Trade
The Court reiterated that Section 47(vii) applies only to capital assets and Stock-in-trade is expressly excluded from the definition of capital asset under Section 2(14). Thus, exemption under Section 47(vii) cannot apply where shares are held as trading assets.
It elucidated,
“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”,
3. Scope of Section 28
The Court emphasised the wide amplitude of Section 28, noting that Business income can arise in cash or in kind and Transfer or sale is not a condition precedent. It held that Realisation may occur through substitution or extinguishment. Reliance was placed on Mazagaon Dock Ltd., T.V. Sundaram Iyengar and Woodward Governor India Pvt. Ltd.
It observed,
“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”,
4. Amalgamation and Realisation of Trading Assets
The Court held that in an amalgamation Shares of the amalgamating company cease to exist and their value is realised either in cash or shares. For a trader, this constitutes commercial realisation.
It added,
“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”,
The Court distinguished Rasiklal Maneklal as being confined to capital gains, clarified in Grace Collis, and held it inapplicable to business income.
5. Rejection of “Notional Income” Argument
The Supreme Court rejected the contention that income was hypothetical. It held that the right to receive shares under a court-sanctioned scheme is enforceable and the Value is ascertainable. Hence, income is real and accrued, not contingent.
It emphasised,
“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”,
Conclusion:
Furthermore, the Court stated that the exchange of one trading asset for another, such as receiving shares in an amalgamated company instead of shares held as stock-in-trade in the amalgamating company, cannot simply be considered a continuation of an investment. It signifies a commercial realization in kind, as the new shares are distinct assets with a clear and readily realizable market value.
It emphasized,
“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 unrealized 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,”
Thus, the Court concluded that the statutory substitution of shares from the amalgamating company with shares in the amalgamated company is not a neutral exchange; since the new shares are marketable and have definitive commercial value, this event constitutes a commercial realization that generates taxable business income.
Consequently, the Apex Court dismissed the Appeals and upheld the contested Judgment.
Case Title: M/s Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II, New Delhi (Neutral Citation: 2026 INSC 46)
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