The Supreme Court has ruled that shares allotted pursuant to a corporate amalgamation may attract tax as business income in the year of allotment if they replace shares held as stock-in-trade and yield an immediate, commercially realisable benefit.

A Bench of J B Pardiwala and R Mahadevan held that where trading shares of an amalgamating company are substituted with shares of the amalgamated company under a statutory scheme, and the new shares are freely marketable and capable of definite valuation, the transaction may constitute taxable business income under Section 28 of the Income Tax Act.

 The court clarified that such substitution is not a tax-neutral event merely because it occurs by operation of law.

The case stemmed from the merger of Jindal Ferro Alloys Limited into Jindal Strips Limited.

The assessees, who held shares in the transferor company, received shares of the transferee company on amalgamation. The key question was whether this allotment itself triggered tax liability, given that the original holdings were treated as trading assets rather than capital investments.

The assessing authority denied exemption under Section 47(vii), which is confined to capital assets, and treated the transaction as a realisation of stock-in-trade, taxing the differential value as business income. While the Income Tax Appellate Tribunal had initially ruled in favour of the assessees, the Delhi High Court overturned that decision, holding that substitution of trading stock through amalgamation could generate taxable profits.

Affirming the high court’s view, the Supreme Court underscored that Section 47(vii) does not extend to shares held as stock-in-trade. The court reiterated that Section 28 has a wide ambit and can bring to tax profits realised in kind, not only those realised through an actual sale.

Where the substituted shares confer a real and presently realisable commercial advantage, the event constitutes a business realisation.

To determine when such a substitution becomes taxable, the court laid down a three-fold test: The original stock-in-trade must cease to exist in the assessee’s books; the shares received must have a definite and ascertainable value; and the assessee must be in a position to immediately dispose of the shares and realise money.

If these conditions are met, the income is taxable in the year of allotment. If not, tax liability arises only upon eventual sale.

The court emphasised that the decisive inquiry under Section 28 is not the technical existence of a sale or exchange, but whether the business transaction results in a real, presently disposable commercial benefit. Shares must therefore be readily available for trading to be treated as stock-in-trade at the stage of substitution.

The Supreme Court upheld the high court’s direction remanding the matter to the ITAT to first determine whether the original shares were held as trading assets or capital assets. If they are found to be stock-in-trade, the tribunal must then apply the court’s three-pronged test to decide whether taxable business income arose in the relevant assessment year.