The Supreme Court has clarified the circumstances under which shares received by a shareholder after a company amalgamation can be treated as business income and taxed under Section 28 of the Income Tax Act, 1961. The decision confirms that receiving new shares in place of old ones does not automatically mean a tax-free corporate restructuring — taxability depends on the true nature of the gain.
A bench of Justices J.B. Pardiwala and R. Mahadevan explained that if the old shares held in the amalgamating company were stock-in-trade (i.e., held for the purpose of business trading), and they are replaced by shares of the amalgamated company that are freely marketable and commercially realisable, then the transaction gives rise to business profits. Such profits can be taxed under Section 28 in the year of allotment itself, even if no sale has taken place.
The Court set out a three-part test to determine when taxability arises:
The original shares held as stock-in-trade must cease to exist in the books of accounts;
The shares received in the amalgamated company must have a definite and ascertainable market value; and
The shareholder must be in a position to immediately dispose of those shares and realise money. If all these conditions are satisfied, the substitution is treated as a commercial realisation of profit subject to tax.
The ruling also stressed that this tax treatment is distinct from the capital gains regime under Section 47(vii), which provides exemption for transfer of capital assets on amalgamation. That exemption applies only when shares are held as capital assets and not as stock-in-trade. If the substituted shares are not immediately realisable (for example, if they are unquoted or subject to lock-in restrictions), then no business income arises at that stage; taxability may then be deferred until the shares are sold.
The Supreme Court affirmed the view of the Delhi High Court and remanded the matter to the Income Tax Appellate Tribunal (ITAT) to determine whether the original shares were indeed stock-in-trade and, if so, to apply the Court’s test to decide taxability.
In short
Shares received on amalgamation may be taxable as business income if the original shares were stock-in-trade and the new shares are commercially realisable.
The key is whether the transaction results in a realisable commercial benefit under Section 28.
If not immediately realisable, tax liability arises only upon eventual sale
