The merger of Reliance Pertroleum (RPL) with Reliance Industries (RIL) is the latest in a long string of amalgamations and mergers that have taken place over time in the Reliance group.

As per the arrangement announced by RIL, RPL shareholders of RPL will get one share of RIL for every 16 RPL shares held by them. Though the merger is effective April 1, 2008, the record date, i.e. the actual date when the shares will be swapped, hasn’t been announced yet. When the announcement does come in, RPL shareholders will own RIL shares in lieu of their RPL shares.

Would such a share swap entail any tax consequences?
Is capital gains tax payable?

What about cost of acquisition and period of holding?
This week’s article examines these and other related issues.
First and foremost, from the tax point of view, RPL will be the amalgamating company, while RIL will be the amalgamated company.

As per the provisions of Sec. 47(vii) read with Sec. 49(2), any transfer by a shareholder in a scheme of amalgamation of shares held by him in the amalgamating company shall not be regarded as transfer if-

a. transfer is made in consideration of allotment to him of shares in the amalgamated company ; and

b. amalgamated company is an Indian company.

What this means is that any exchange of shares held in the amalgamating company (RPL) will not be considered as a sale and consequently there will be no capital gains/ loss as long as the transfer is made in consideration for being allotted shares in the amalgamated company (RIL).

Moreover, the cost of shares of RPL will be considered as the cost of shares of the new shares allotted of RIL.

Readers would know that in order for shares to qualify as long-term assets and consequently as long-term capital gains upon sale, they have to be held for over 12 months.

Now, in this case, to ascertain whether the freshly allotted RIL shares are long-term or not, the period of holding of RPL shares would also be considered.

Indexation however, will start from the date of allotment of RIL shares.

Let’s understand all this in terms of an example.
Let’s say Vishal has acquired 400 shares in RPL on December 15, 2008 @Rs 90 per share. Therefore, his total cost is Rs 36,000 (Rs 90 X 400 shares). Now, on the record date, his holding of 400 shares in RPL will be converted into 25 RIL shares (400/ 16). His total cost remains the same, i.e. Rs 36,000, yielding a net cost per RIL share of Rs 1,440 (Rs 36,000/ 25 RIL shares).

Let’s say, going forward, Vishal sells his holding of 25 RIL shares on December 31, 2009 at Rs 1,600 per share. He would get Rs 40,000 on selling the shares. The capital gain earned would be Rs 4,000 (Rs 40,000 less Rs 36,000). Also, though he has technically held the RIL shares for less than 12 months (from record date which will be on or after April 1, 2009 till December 31, 2009), since the period of holding of the erstwhile RPL shares has to be aggregated, this capital gain would be long-term in nature and hence free of tax.

In the above illustration, the example of a shareholder who holds RPL shares that are an exact multiple of 16 has been used for ease of understanding,. But in real life, this may not be so. What if one holds only 15 shares or perhaps 200 or even 300 — in short a number that is not exactly divisible by 16 such that you get a precise round figure of RIL shares.

Though it is not clear from the terms so far, in all probability RIL would compensate for the fractional shareholding in cash.
In this regard, in the case ofGautam Sarabhai Trust, 173 ITR 216 the Gujarat High Court held that if besides shares, the shareholders of the amalgamating company are allotted something more in exchange like say bonds or cash, etc., then the swap will not get the benefit of exemption from capital gains.

However, experts are of the opinion that the above ruling is applicable only in cases where the offer for shares plus cash / bonds is a part and parcel of the terms of the merger itself and not where the cash comes into the picture only to account for fractional ownership. For example, if the offer were one RIL share plus say Rs. 50 in cash for every 16 shares of RPL, the swap would be considered as a transfer and capital gains tax would apply. But since the offer is of one RIL share only (and nothing else) for every 16 shares held and cash, if at all, comes into play because fractional shares cannot be offered, the spirit of the law isn’t revoked and hence there would be no capital gain.

Conclusion? The RIL-RPL merger will be completely tax neutral for all shareholders of RPL.

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