In case of Amalgamation, either Capital Reserve or Goodwill is created by the amalgamated company. In other words, if the consideration is more than the net assets taken over, the differential amount is treated as Goodwill. However, where the value of net assets taken over is more than the sales consideration, the differential amount is treated as Capital Reserve. While the amalgamated company claims depreciation on goodwill so created1, no tax effect is given by the amalgamated company with respect to Capital Reserve.
As per section 56(2)(viib) of the Income-tax Act, 1961 (IT Act) where the shares are issued for a consideration in excess of Fair Market Value (FMV), the excess of sales consideration over FMV is treated as Income of the Company issuing the shares. Thus, in an amalgamation where the net assets taken over is more than the FMV of the shares issued by the amalgamated company, the tax officer may apply section 56(2)(viib) of the IT Act.
In this regard, recently, the Ahmedabad Tax Tribunal2 (Tax Tribunal) had an occasion to examine whether the provisions of Section 56(2)(viib) of the Income-tax Act, 1961 (IT Act) would get attracted when the shares are issued pursuant to a Scheme of Arrangement.
We, at BDO in India, have summarised the ruling of the Tax Tribunal and provided our comments on the impact of this decision hereunder:
Facts of the case
The taxpayer had entered into a scheme of arrangement whereby a private limited company - KEPL – was amalgamated with it. The amalgamation scheme was approved by the Hon’ble Gujarat High Court w.e.f. from 1 April 2012. Pursuant to amalgamation, all assets, liabilities, undertaking of KEPL (amalgamating company) vested with the taxpayer (amalgamated company). While all the assets (except land) and liabilities of KEPL were taken at the book value, land parcels were taken at revalued price. In terms of Accounting Standard 14 issued by The Institute of Chartered Accountants’ of India, the amalgamation was recorded under the ‘pooling of interest’ method. Hence, the excess of net assets received (i.e. assets minus liabilities) over the value of shares issued by the taxpayer was credited to the “Capital Reserve Account” in the taxpayer’s books. The tax officer opined that the amount credited to the “Capital Reserve” account was liable for taxation in the hands of the taxpayer as it was excess consideration towards issue of share. Further, the Tax Officer worked out the FMV of the taxpayer’s shares which came to an amount less than the face value of shares. Accordingly, the tax officer computed the difference between the FMV of shares and the net assets received and brought it to tax under section 56(2)(viib) of the IT Act. The taxpayer preferred appeal before the First Appellate Authority which was ruled in its favour. Aggrieved, the Revenue Authority appealed before the Tax Tribunal.
Tax Tribunal’s Ruling
The Tax Tribunal concurred with the view of First Appellate Authority and held that the provision of section 56(2)(viib) of the IT Act shall not apply where shares are issued in pursuance to scheme of amalgamation. While coming to this conclusion, the Tax Tribunal made the following observations:
1. Intent of Section 56(2)(viib) of the IT Act
- On perusing the provisions of section 56(2)(viib) of the IT Act, following emerges:
- consideration which is taxable is the one which exceeds face value of shares issued;
- in the event of shares issued at consideration above face value, the same need to be compared with FMV determined and the consideration received in excess of FMV is deemed as income of issuing company.
- In the instant case, the taxpayer has issued shares at face value.
- On combined reading of section 56(2)(viib) of the IT Act and statutory documents3, it appears that the whole thrust for such insertion is to bring measures to tax hefty or excessive share premium received unjustifiably by private companies on issue of shares without carrying underlying value to support such premium. It also seemed that subscription to the shares issued by a company at a substantial premium (not necessarily backed by justifiable valuation) was supposedly resorted to convert unaccounted money.
- Section 56(2)(viib) of the IT Act creates a deeming fiction to imagine and fictionally convert a capital receipt into revenue income.
- Relying on the Hon’ble Supreme Court decision in the case of Mother India Refrigeration (P) Ltd4, it was opined that deeming fiction cannot be stretched beyond its purpose and import another fiction in it. In light of this understanding, the provisions of section 56(2)(viib) of the IT Act shall not come to motion where the taxpayer has not charged premium at all and the shares were issued at face value.
2. Section 56(2)(viib) of the IT Act does not apply to amalgamation
- The issue of shares is to give effect to the amalgamation, as per mutual agreement and the Court order. Further, the shares are issued as consideration for the amalgamation and not vice versa.
- Section 56(2)(viib) of the IT Act contemplates a transaction between a resident person and the company issuing shares. In amalgamation, the consideration, which would be Undertaking along with all its assets and liabilities is in the form of vesting by the amalgamating company, whereas the shares are issued to its shareholders. Thus, it is, in effect, a tripartite agreement between (i) amalgamated company (ii) amalgamating company (iii) the shareholders of amalgamating company. Such tripartite arrangements in amalgamation cases are not contemplated in the deeming clause of section 56(2)(viib) of the IT Act.
- Section 56(2)(viib) of the IT Act is not applicable when consideration is received by Venture Capital Undertaking from issue of shares to a Venture Capital Company/Fund. This implies that there should be an issue of shares directly by the company to the subscriber, for consideration i.e., it contemplates a bilateral transaction.
3. Exemption from the ambit of ‘transfer’ granted to shareholders of amalgamating company
- The IT Act contemplates that there arises “transfer” of shares by the shareholders of the amalgamating company in consideration of the allotment of shares by the amalgamated company. With a view to neutralise tax effect, the IT Act provides for suitable exemption by excluding such transaction from the ambit of “transfer”. Thus, a bare issue of shares as contemplated in section 56(2)(viib) of the IT Act cannot be equated with a situation of “transfer” for which specific exemption is provided in section 47 of the IT Act.
The Tax Tribunal has made an important observation that in case of amalgamation, shares are issued as consideration. For section 56(2)(viib) of the IT Act to get attracted, shares should be issued for a consideration. As this is not present in case of amalgamation, section 56(2)(viib) of the IT Act is not attracted. Applying this analogy to other scheme of arrangement (viz. demerger, slump sale etc.), one could contend that section 56(2)(viib) of the IT Act to such scheme of arrangement. Furthermore, the ruling also lays down an important principle that the provisions of Section 56(2)(viib) of the IT Act shall not apply to a tripartite arrangement.
Having said this, it is imperative to take note of General Anti-Avoidance Rule (GAAR) which was not in existence for the year for which the Tax Tribunal rendered its ruling. With GAAR provision being effective, if the tax officer treats the scheme of arrangement as impermissible transaction, one needs to see how will provision of section 56(2)(viib) of the IT Act would function in such a case.
1Finance Act, 2021 has amended relevant provisions of the IT Act to treat goodwill as non-depreciable asset. Hence, with effect from 1 April 2021, depreciation on goodwill is not available.
2DCIT vs. M/s Ozone India Ltd., ITA No. 2081/Ahd/2018 - Ahmedabad Tax Tribunal
3Explanatory Memorandum to Finance Bill, 2012;
The Budget 2012 speech by the Finance Minister;
Circular No. 3/2012, dated 12 June 2012
4CIT vs. Mother India Refrigeration (P) Ltd  155 ITR 711 (Supreme Court)