Capital reserve arising from amalgamation in the nature of merger is a capital receipt

IN THE ITAT KOLKATA BENCH ‘B’

Income-tax Officer, Ward 7(3), Kolkata

Versus

Shreyans Investments (P.) Ltd.

IT Appeal No. 1485 (Kol.) of 2011
[ASSESSMENT YEAR 2008-09]

MARCH  6, 2013

ORDER

Pramod Kumar, Accountant Member 

By way of this appeal, the appellant Assessing Officer has called into question correctness of learned Commissioner (Appeals)’s order dated 8th August 2011, in the matter of assessment under section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) for the assessment year 2008-09, on the following grounds:

1.            That, on the facts and in the circumstances of the case, the learned CIT(A) has erred in considering the issue of shares by amalgamated company to the shareholders of amalgamated company in lieu of transfer of undertaking of the amalgamating company are all transfers within the meaning of section 2(47(i) of the Income Tax Act, 1961. Therefore, the said order of the learned CIT(A)- VII, Kolkata is perverse and liable to be quashed.

2.            That, on the facts and in the circumstances of the case and in law, the learned CIT(A)- VII Kolkata has erred in considering the provisions of Section 47(vii) of the Income Tax Act, 1961, when it has not been relied upon by the assessee during the course of assessment proceedings under section 143(3) of the Income Tax Act, 1961. Therefore, the said order of the learned CIT(A)- VII, Kolkata is perverse and liable to be quashed.

3.            That, on the facts and circumstances of the case and in law, the learned CIT(A)- VII Kolkata has erred in not providing any opportunity to the undersigned while considering the provisions of Section 47(vii) of the Income Tax Act, 1961, in favour of the assessee, which makes the order bad in law and perverse.

4.            That, on the facts and circumstances of the case and in law, the learned CIT(A)- VII Kolkata has erred in concluding that the amalgamation is not an adventure in the nature of trade, without negating the reasons to the contrary, mentioned in order under section 143(3) of the Income Tax Act, 1961 dated 28.12.2010. That, on the facts and circumstances of the case and in law, the learned CIT(A)-VII Kolkata has erred.

5.            The appellant craves the leave to add, alter or abrogate any grounds of appeal at the time of hearing.

2. The relevant material facts are not in dispute. The assessee before us is a company registered under the Companies Act, 1956. The return of income filed by the assessee, which disclosed a loss of Rs 1,26,760, was selected for scrutiny assessment under the Computer Aided Scrutiny Selection (CASS) scheme. In the course of these scrutiny assessment proceedings, the Assessing Officer noticed that the company had increased its share capital, and that an amount of Rs 2,06,87,692, which was shown as ‘Capital Reserve (other than profit and loss account)’, was to shown in the current year’s balance sheet, whereas no such amount was reflected in the immediately preceding year’s balance sheet. In response to the Assessing Officer’s requisition to explain these facts, it was submitted by the assessee that the assessee company was part to am amalgamation scheme, duly approved by Hon’ble Calcutta High Court, wherein one Vidya Vincon Private Limited (VVPL, in short), i.e. amalgamating company, amalgamated in the assessee company with effect from 1st April 2007. It was also explained that the capital reserve of Rs 2,06,87,692 came into existence in the books of the assessee, on account of amalgamation with VVPL. The Assessing Officer, on these facts, called upon the assessee to show cause as to why the amount of Rs 2,06,87,692, being the capital reserve credited by the company on amalgamation, not be treated as income of the assessee under section 28(iv) of the Income Tax Act, 1961. The assessee’s explanation was that the said amount is neither a benefit, nor a perquisite, nor even advantage of any kind, but simply a result of merger of accounts of amalgamating and amalgamated company. This explanation did not satisfy the Assessing Officer. He rejected the submissions of the assessee, and, in a very scholarly discussion, observed as follows:

(i)           It appears that the assessee is an investment company and had an accumulated profit of Rs. 6,36,196/- as on 31.03.2007 and Rs.3,14,944/- as on 31.03.2008. The earning per share of the company in Rupees is (12.85). Likewise M/s. Vidya Vincom Pvt. Ltd. is also an investment company and had an accumulated profit of Rs.2,529/- and Rs.4,552/- as on 31.03.2006 and 31.03.2007 respectively. The earning per share of the company (in Rupees) has been mentioned in the audited accounts for the year ended on 31.03.2007 as negligible. No dividend has been distributed by both the companies in any of the previous years.

(ii)          It has been found that the assets and liabilities of the amalgamated company had been taken over by the amalgamating company which resulted in income of Rs. 2,06,87,692/- after deducting capital Suspense Account of Rs. 82,15,980/- from the net worth (assets – liabilities) of the amalgamated company. The amount of Rs. 2,06,87,692/- represents the difference owning to the swap ratio determined by the Hon’ble High Court at Calcutta. Therefore, it is clear that there is a surplus amount of the net worth after allocation of share capital to the share holders of the amalgamated company as per Court’s order.

(iii)         As already stated, that the performance of both the amalgamated and amalgamating companies is more or less similar. The said two companies are investment companies having no business activities. Therefore, the reason for amalgamation is unknown.

(iv)         The word ‘Business’ was defined in the Act under section. 2(13). The definition is not exhaustive; it covers every facet of an occupation carried on by a person with a view to earning profits. The word ‘business’ under section 28 has a very broad meaning and may be used in different connotations. The section also refers to an adventure in the nature of trade. In this regard, reference is being drawn to the decisions in the case of Rajputana Textiles (Agencies) Ltd. v. CIT [1961] 42 ITR 743 (SC), where it was held that where from the very beginning, purchase of shares is made with the intention of selling them, at a profit, it is an adventure in the nature of trade.

(v)          The purpose of existence of the assessee is to conduct business and as a result earn profit. It will not be far fetched to assume that all the activities of the assessee are driven towards its motive of conducting business and earn profit. Therefore, this exercise of amalgamation is also aimed at bolstering the capability of the assessee to conduct business more dynamically and earn more profit. So, the enhancement of its capital reserve, as a result of this amalgamation can only be construed as a benefit accrued to the assessee.

               This is not a hypothesis, but can be postulated to actual situation also. The block of assets that the amalgamated assessee company receives is definitely tangible assets that the assessee will enjoy. The bolstered figure of capital reserve can boost its image and goodwill. It can also profit it with more leverage to access loans for expansion or other activities in business. So, in a nutshell, it can be surmised that the assessee is benefited in a myriad ways by way of amalgamation. The assessee in its sane mind will not venture into this exercise of amalgamation, without going into the due diligence of evaluating the pros and cons of an amalgamation with another company. When it has done so, its only motive can be to derive maximum benefit out of it. Therefore, the net result of enhancement of ‘Capital Reserve’ to the tune of Rs.2,06,87,692/- can only be termed as a benefit accruing to the assessee under section 28(iv) of the Income Tax Act, 1961.

               In the instant case, the intention of the amalgamating company, i.e. the assessee company was to earn profit as there was no reason to amalgamation particularly where the performance of both the company were alike and there was no actual business shown by it during the past year (other than investment in mostly in private limited companies). Therefore, the resultant of amalgamation is considered as a business transaction and the profit arising out of merging of accounts of the amalgamated company with the amalgamating company is business income which is in the nature of benefit or perquisite arising from business or the exercise of a profession, covered under section 28(iv) of the Income Tax Act, 1961. In view of this, Rs.2,06,87,692/- is added to the total income of the assessee under the head ‘Business’.

3. Aggrieved by the stand so taken by the Assessing Officer, the assessee carried the matter in appeal before the CIT(A). Learned CIT(A) deleted the impugned addition, and observed as follows:

I have gone through the submissions of the A.R. and the order of the AO, I agree with the A/R that the amalgamation of the two companies are consequent transfer of assets of amalgamating company into amalgamated company and issue of shares by amalgamated company to the shareholders of amalgamating company in lieu of transfer of undertaking of amalgamating company are all transfers within the meaning of section 2(47)(i) of Income Tax Act and are to be charged as capital gains on two counts, one in the hands of amalgamating company and secondly in the hands of shareholders of amalgamating company. However, as per section 47(vi) and section 47(vii), these transfers are outside the purview of capital gains.

The legislature in its wisdom has treated certain transactions in course of amalgamation outside the purview of ‘transfer’ for taxation purposes.

Section 47(vi) specifically states ‘any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company if the amalgamated company is an Indian Company’/

Section 47(vii) states that ‘any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the amalgamating company, if-

(a)          the transfer is made in consideration of the allotment to him for any share or shares in the amalgamated company; and

(b)          the amalgamated company is an Indian Company.

The amalgamation is not an adventure in the nature of trade. This transaction is clearly a capital account transaction. I further find that ICAI AS-14 (Accounting for Amalgamation) read with Expert opinion published in C.A. Journal (April 2004) has also opined that the difference in the share capital issued by the transferee company on amalgamation and amount of share capital of the transferor companies is of capital nature. Accordingly, the difference should be treated as capital reserve, since it is akin to share premium.

The Kolkata ITAT in ML Dalmia and Company case (supra) has also observed that amalgamation reserve cannot be treated as income of the appellant. Thus, I conclude that amalgamation reserve of Rs.2,06,87,692/- cannot be treated as business income under section 28(iv) of the Income Tax Act. Thus Ground No. 1 is decided in the favour of the appellant.

4. The Assessing Officer is aggrieved, and is in appeal before us.

5. We have heard the rival contentions, perused the material on record and duly considered factual matrix of the case as also the applicable legal position.

6. We find that there is no dispute about the fundamental factual position that it is a case of amalgamation of companies, and it is as a result of this scheme of amalgamation, duly approved by Hon’ble jurisdictional High Court – a copy of which is placed on our records as well, that the capital reserve of the amalgamating company, i.e. VVPL, was shown in the books of accounts of the assessee. The short question that we really need to answer is whether on these facts, the transfer of capital reserve to the assessee company can indeed be considered to be an income of the assessee under section 28 (iv) as a ‘business income’. As we deal with this issue, we may also mention that given these facts, as far as learned CIT(A)’s reliance on this Tribunal’s decision in the case of DCIT v. M L Dalmiya & Co Ltd (98 ITD 93) is concerned, it is really out of place inasmuch as the question before the Tribunal in the said case whether an addition, in respect of entries pertaining to inter alia share amalgamation reserve, can be made to the ‘undisclosed income’ under section 158 BB – particularly when all the relevant details were furnished at the time of regular assessment proceedings. Answering this question, the co-ordinate bench observed that, “Coming to the merits of the case, we find that the learned CIT(A) has deleted the addition observing that the addition made by the Assessing Officer on account of undisclosed income was not justified at all as all the transactions pertaining to the share amalgamation reserve and share application money were duly recorded in the books of accounts and were filed before the date of search in the form of account and were filed before the income tax department before the date of search and in the form of audited statement, and, therefore, the same cannot be taxed as undisclosed income of the assessee” [emphasis by underlining supplied by us now]. Be that as it may, let us come back to the question that we have posed for our ourselves and the question, which, in our humble understanding, is decisive factor in this appeal.

7. Section 28 sets out the incomes which are chargeable to income-tax under the head ‘Profits and gains of business and profession’, and clause (iv) thereto refers to “the value of any benefit or perquisite, whether convertible into money or not, arising from the business or exercise of a profession”. It is thus clear that besides the profits and gains from business and profession carried on by the assessee at any time during the previous year, any other benefit or perquisite, whether convertible into money or not, is also chargeable to tax under this head of income. A plain reading of this provision shows two conditions precedents for such taxability i.e. (i) that there should be benefits or perquisites; and that (ii) that such benefits or perquisites should arise from the business or exercise of the profession. The expression ‘arising from the business’ essentially implies that the benefit or perquisite must be in the nature of a business receipt or revenue receipt. No matter how wide be the scope of Section 28(iv), the difference between a capital receipt and revenue receipt cannot be overlooked. In the case of Mahindra & Mahindra Limited v. CIT (261 ITR 501), Hon’ble Bombay High Court has, in the context of this significant distinction between revenue and capital receipts, held that waiver of principal amount in respect of imports of plant and machinery could, by no stretch of logic, be treated as ‘business income’, and, therefore, as an income taxable under section 28(iv). One must bear in mind the fact that section 28 only refers to the “income” which can be charged to income tax under the head “profits and gains from business or profession”, and, therefore, when a particular advantage, perquisite or receipt is not in the nature of income, there cannot be any occasion to bring the same to tax under section 28(iv). Hon’ble Supreme Court, in the case of Padmaraje R Kadambande v. CIT (195 ITR 877) observed that, “…we hold that the amounts received by the assessee during the financial year in question have to be regarded as capital receipts, and, therefore, are not income within meaning of section 2(24) of the Income Tax Act.” (Emphasis by underlining supplied by us). This clearly shows, as is the settled law, that a capital receipt, in principle, is outside the scope of income chargeable to tax. Of course, there are specific provisions under the Income Tax Act which provide that certain capital receipts can also be considered as income, such as under section 2 (24)(vi) which covers “any capital gains chargeable under section 45”, but right now we are confined to normal connotations of the expression ‘income’. Howsoever liberal or narrow be the interpretation of expression ‘income’, it cannot alter character of a receipt, i.e. convert a capital receipt into revenue receipt or vice versa. The crucial distinction between capital and revenue cannot be blurred or nullified by even the most liberal interpretation of expression ‘income’. It is also important to bear in mind that, as held by Hon’ble Supreme Court in the case of Dr K George Thomas v. CIT (156 ITR 412), “the burden is on the revenue to establish that the receipt is of a revenue nature” though “once a receipt is found to be of revenue character, whether it comes under exemption or not, it is for the revenue to establish”. It is thus clear that capital receipts are inherently outside the scope of an income which can be taxed under section 28(iv), and Hon’ble Bombay High Court, in the case of Mahindra & Mahindra (supra) also holds so. As to what constitutes capital receipt, we find guidance from Hon’ble Madras High Court’s judgment in the case of CIT v. Seshasayee Brothers Pvt Ltd (222 ITR 818) wherein Their Lordships, after elaborately surveying the legal precedents on this issue, concluded that, “Thus, a combined reading of the abovesaid judicial pronouncements would go to show that when a receipt is referable to fixed capital, it is not taxable, and it is taxable as a revenue receipt when it is referable to circulating capital or stock in trade”. To sum up, unless it is a revenue receipt, it cannot be in the nature of income [except in a situations in which capital receipts are specifically included in the definition of income such as under section 2(24)(vi)], and unless it is in nature of income, it cannot be considered for taxation under section 28(iv). The reference to benefits which can be brought to tax under section 28(iv) for benefits ‘arising from the business’ also indicates that such benefit must be a business receipt, or revenue receipt, in nature.

8. To find out whether or not the benefit, even if that be so, is on capital account or revenue account, it is necessary to understand the nature of transaction which has resulted in, what the Assessing Officer, perceives as ‘benefit to the assessee’. This was a case of amalgamation in the nature of merger, and an amalgamation in the nature of merger, in corporate parlance, is the process of blending of two or more companies into one of these blending companies, the shareholders of each blending company becoming substantially the shareholder of the company which holds the blended undertaking. The expression ‘amalgamating company’ is used for the ‘blending company’ which loses its existence into the other company and the expression ‘amalgamated company’ is used for blended undertaking, which holds existence of those two or more companies. In essence thus, the whole exercise of amalgamation in the nature of merger is an exercise in that of pooling of resources, as also pooling of assets, into the company in which two or more companies are blended. It is a process of corporate reconstruction and it is only with the approval of Hon’ble jurisdictional High Court that this exercise is carried out. In the present case also, as stated in paragraph 4 of Part I of Schedule A (i.e. scheme of amalgamation) to Hon’ble Calcutta High Court’s order dated 9th April 2008, “for the purpose of better, efficient and economical management, control and running of the business and to withstand the recessionary trend in the economy of the business undertaking concerned and for administrative convenience and to obtain advantage of economies of large scale, the present scheme is proposed to amalgamate the transferor company (i.e. VVPL) with the transferee company (i.e. the assessee)”. As a result of amalgamation, the assessee, being the transferee company, will increase its assets and liabilities, and, even if there be any benefit in the process, such a benefit can only be in the capital field because it is relatable to the non trading assets and capital. What it affects is the capital structure of the assessee company and the manner in which business is consolidated. As the Assessing Officer himself observes, “……this exercise of amalgamation is also aimed at bolstering the capability of the assessee to conduct business more dynamically and earn more profit. So, the enhancement of its capital reserve, as a result of this amalgamation can only be construed as a benefit accrued to the assessee…”, but then it is not even the case of the Assessing Officer that the benefit is in the revenue field, and unless the Assessing Officer is to discharge the onus of demonstrating that the benefit is in the revenue field, there cannot be any occasion to invoke Section 28(iv). Applying the test laid down by Hon’ble Madras High Court, in the case of Seshasayee Brothers (supra), also, we find that the benefit is referable to the capital, and is thus not of an income nature. Even if, as the Assessing Officer observes, “it can be surmised that the assessee is benefited in a myriad ways by way of amalgamation”, it does not lead to the conclusion that the benefit is in revenue field which alone can be treated as income and thus be considered for taxability under section 28(iv) of the Act. The onus is on the Assessing Officer to demonstrate that the receipt is of the revenue nature.

9. We have noted that the Assessing Officer’s observations to the effect that ‘business’ under section 28 has a very broad meaning and may be used in different connotations” and that it includes adventure in the nature of trade, as also his reliance on Hon’ble Supreme Court’s judgment in the case of Rajputana Textiles (Agencies) Ltd. v. CIT 42 ITR 743 (SC), wherein it was held that where from the very beginning, purchase of shares is made with the intention of selling them, at a profit, it is an adventure in the nature of trade. However, we are unable to see any merits in these arguments either. Whatever be the scope of expression ‘business’, an advantage has to be of income nature first, and when it is not of income nature, it cannot be brought to tax under the head profits and gains from business or profession. As regards the transactions in the nature of ‘adventure in the nature of trade’ in a situation in which shares are purchased with an intention of selling the same, right now we are dealing with a case of amalgamation by way of merger and not by way of purchase of shares, and, therefore, there cannot be any question of selling of the shares, nor does this judicial precedent deal with the issue before us in any other manner. There is no material whatsoever before us to indicate that the benefit, even if accruing to the assessee, was in revenue field, in the course of assessee’s business dealings or of trading nature. In view of these discussions, we are of the considered view that the benefit, if any, derived by the assessee on account of amalgamation by way of merger was not in revenue field, and not of an income nature. Accordingly, there was no occasion to invoke Section 28(iv) of the Act. Learned CIT(A) was quite justified in his observations that “the amalgamation is not an adventure in the nature of trade” and that “this transaction is clearly a capital account transaction”. Learned CIT(A) was quite justified in deleting the impugned addition, we uphold his conclusions, and we decline to interfere in the matter.

10. As we have decided the appeal on the fundamental issue that the benefit, even if any, was not in the revenue field, and could not have been brought to tax under section 28(iv) for this short reason, we see no need to deal with other peripheral legal issues raised by the parties, as also assessee’s contention to the effect that there was no benefit at all to the assessee. These issues are rendered academic and call for no adjudication.

11. In the result, the appeal is dismissed.