From Capital Assets to Stock-in-Trade: Taxing “Notional” Gains in Amalgamations

Decoding Supreme Court ruling in Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II, New Delhi

– Sourish Kundu | corplaw@vinodkothari.com

One of the most common modes of corporate restructuring is merger, and one of the most crucial aspects in assessing the commercial viability of a proposed merger is its tax implications. Typically, in a merger, the shareholders of the transferor company are issued shares of the transferee company in order to avail the exemption under section 70(1)(f) of the IT Act, 2025 [corresponding to section 47(vii) of the IT Act, 1961]. The said provision grants exemption in case of scheme of amalgamation in respect of the transfer of a capital asset, being shares held by a shareholder in the transferor company, where (i) the transfer is made in consideration of the allotment of shares in the transferee company (other than where the shareholder itself is the transferee company) and (ii) the amalgamated company is an Indian company.

However, a recent Supreme Court ruling in the matter of Jindal Equipment Leasing Consultancy Services Ltd. v. Commissioner of Income Tax Delhi-II, New Delhi [2026 INSC 46] has opened a new avenue for debate w.r.t the taxation on receipt of shares of the transferee company in a scheme of amalgamation. In this case, the Supreme Court ruled that the exemption as provided under section 47(vii) of the IT Act, 1961 [corresponding to section 70(1)(f) of the IT Act, 2025] shall not be available to shareholders of the transferor company who are not perceived as “investors”, that is to say long term investors as opposed to traders, in the transferor company. And accordingly, any notional gain in a share swap deal pursuant to an amalgamation shall be taxed u/2 28 of the IT Act, 1961 [corresponding to section 26 of the IT Act, 2025].

In this article, we decode the nuances of the ruling, the impact it is expected to have in the sphere of merger deals and other related concerns.

Difference between capital and business assets

So far, the common understanding of consideration in case of amalgamations was that an amalgamation is merely a statutory replacement of one scrip for another, with no real “transfer” or “income” until the new shares are actually sold for cash, or in other words, mere substitution of shares in the books of the involved entities. However, the Apex Court in the instant judgement has now effectively set a different precedent for those holding shares as stock-in-trade, i.e. current investments.

The Court clarified that while Section 47(vii) provides a safe harbor for investors (treating mergers as tax-neutral corporate restructuring), this exemption does not extend to “business assets”, a.k.a. stock in trade. For a trader and investment houses, shares held in stock-in-trade represent “circulating capital”, and the objective of holding them is not capital appreciation, but conversion into money in the ordinary course of business. Therefore, replacing shares of an amalgamating company with those of an amalgamated company of a higher, ascertainable value constitutes a “commercial realisation in kind”.

The 3 pillar test for taxability

The SC applying the doctrine of real income emphasised in Commissioner of Income-Tax v. Excel Industries Ltd. and Anr. [(2013) 358 ITR 295 (SC)], established a three-pillar test, which is to be applied on a case to case basis to determine if allotment of shares pursuant to a merger triggers taxation of business income u/s 28 of the IT Act, 1961: 

1. Cessation of the Old Asset: The original shares must be extinguished in the books of the assessee.
2. Definite Valuation: The new shares must have an ascertainable market value.
3. Present Realisability: The shareholder must be in a position to immediately dispose of the shares and realise money.

This test was further elaborated by two situations viz. allotted shares being subject to a statutory lock-in, which hinders the disposability of the asset, and allotted shares being unlisted, which cannot be said to be realisable, since no open market exists to ascribe a fair disposal value.

Additionally, the SC also held that the trigger is the date of allotment of the shares of the amalgamated entity, and neither the “appointed date” nor the “date of court sanction” or what is called as “effective date” in the general parlance, as no tradable asset exists in the shareholder’s hands until the scrips are actually issued.

Critical Concerns

While the ruling provides reasonable clarity on the treatment of shares received as a result of amalgamation, when the same is held in inventory, it leaves several operational questions unanswered, leaving a gap to determine the commercial feasibility of these deals.

1. Treatment of profits and losses alike

If the Revenue can tax “notional” gains arising from a higher market value at allotment, correspondingly assessees should be allowed to book notional losses, if any on such deals as well. In cases where a merger swap ratio or a market dip results in the new shares being worth less than the cost of the original holding, the taxpayer should, by the same logic, be entitled to claim a business loss u/s 28 of the IT Act, 1961, or in other words, if the substitution is a “realisation” for profit, it must be a “realisation” for loss as well.

2. Increase in cost of acquisition

A major concern is the potential for double taxation. If the assessee is taxed on notional gain, being the difference between the cost of acquisition of the original shares and the FMV of the shares of the transferee company on the date of allotment, such FMV should logically become the new cost of acquisition. If an assessee is taxed on the difference between the book value and the FMV at the time of allotment, but the increased cost of acquisition is not allowed, the same appreciation gets taxed twice. It is first taxed as business income at the time of allotment and again at the time of the actual sale.  

3. Determination of the nature of shares as “stock in trade” vs “capital asset”

This issue remains prone to litigation, that is, who determines the nature of the investment, whether it is current or non-current? Will it be determined basis the books of account of the investor? 

A CBDT circular lays down certain principles along with some case laws to distinguish between shares held as stock-in-trade and shares held as investments, and decide the treatment of shares held by the investing company. Further, factors such as intention of the party purchasing the shares, [discussed by Lord Reid in J. Harrison (Watford) Ltd. v. Griffiths (H.M. Inspector of Taxes); (1962) 40 TC 281 (HL)], and method of recording the investments [highlighted in CIT v. Associated Industrial Development Co (P) Ltd (AIR1972SC445)], are considered as the deciding factors for making a demarcation between treating an asset as capital asset or stock-in-trade.

As highlighted in the instant case, while the initial classification is made by the companies in the financial statements, the AO is empowered to overlook the same, and determine whether the shares were held as stock-in-trade or as capital assets, as without that determination, the taxability or eligibility for exemption u/s 47 could not be ascertained.

It should be noted that the line between a long-term strategic investment and a trading asset is often thin, and the Jindal ruling places the burden on the Revenue to prove the stock status and the “present realisability” of the shares.

Conclusion

Proving by contradiction, the Apex Court has added that: “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 unrealised 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”

Discussing the concept of “transfer”, “exchange” and “realisability”, the SC has affirmed that mergers do not entail a mere replacement of shares of one company with that of another, as for persons holding the same as stock-in-trade cannot be said to be a continue their investment, instead the new shares being capable of commercial realisation gives rise to taxable business income. The Jindal Equipment ruling seems to effectively end the assumption of automatic tax neutrality for all merger participants, subject to fulfillment of applicable conditions prescribed in the IT Act. As a result, if the tax officers believe that the shareholders hold the shares as stock in trade, and could cash out the same at the next possible instance, the assessee shall be under the obligation to pay tax even without encashing any gain in actuals. Further, the tax implications in such cases shall not be at the special rates prescribed for capital gains.

Read more:

Understanding “Undertaking” in the Context of Investment Demergers

Budget 2025: Mergers not to be used for evergreening of losses