Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Tribunal holds “capital reserve”
recorded under the purchase method of accounting for
amalgamation is not “revaluation reserve” for purposes of section 115JB of the Act
August 7, 2020
In brief
The Delhi bench of the Income-tax Appellate Tribunal (Tribunal)1, on facts of the case, rejected the Revenue’s contention to hold scheme of amalgamation (Scheme) as a “sham” transaction or colourable device. The Tribunal further held that capital reserve arising on recording of the Scheme under the purchase method of accounting is not re-valuation reserve, and therefore, out of the purview of section 115JB of the Income-tax Act, 1961 (Act).
In detail
Facts
• The taxpayer had five direct and indirect subsidiaries.
Pursuant to the Scheme, all the five subsidiaries were merged with the taxpayer.
• All the assets and liabilities, which inter-alia includes equity shares in a listed entity, stood transferred to and vested in the taxpayer.
• The taxpayer recorded the assets and liabilities at their respective fair values on the appointed date in
accordance with the purchase method of accounting provided under Accounting Standard (AS)- 14, and such fair value was
1 ITA No. 764/Del/2020
considered as cost in the books of accounts.
• As required by AS-14, the difference between the fair value of assets acquired and the liabilities taken over was recorded as “capital reserve.”
• Post the appointed date and before the amalgamation became effective, the transferor companies sold the equity shares of the listed company on a recognised stock exchange.
• Once the Scheme became effective, the taxpayer recorded capital gain on all the aforesaid sale
transactions. The capital gain was computed by
reducing the book cost (fair value on the appointed date) from the sale consideration.
• As the shares were sold on a stock exchange, the long- term capital gain (being sale consideration minus original purchase cost in the hands of the amalgamating companies) was claimed as exempt under section 10(38) of the Act.
Issues before the Tribunal
• Whether the Scheme was a sham transaction or a colourable device?
• Whether the reserve created on recording the Scheme is in the nature of “revaluation
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reserve” or “capital reserve,”
and whether the upward adjustment in terms of Clause (j) of the Explanation 1 to section 115JB of the Act is required?
Taxpayer’s contentions
• The accounting treatment in the books of accounts, was as per the Scheme approved by the Delhi High Court and in accordance with AS-14. There was no illegality in the Scheme.
• The Scheme and accounting were as permitted by law and have not used any device, subterfuge or dubious method to hoodwink the Revenue.
Therefore, the Tax Officer’s (TO) allegation about the Scheme being a colourable device is without any base.
• The amalgamating companies had real estate development as their object and owned land parcels. The Scheme was proposed to consolidate the businesses of all the
companies into one single entity for improved synergy and management focus. The taxpayer company intends to build a resort project.
• The amalgamation was purely a business and a strategic decision, and it was not a sham transaction to evade tax as alleged by the TO.
Revenue’s contentions
• The Scheme was planned and undertaken as a colourable device and a sham transaction to jack up the value of the assets for the computation of book profits and to reduce liability for the payment of minimum alternate tax under section 115JB of the Act.
Additionally, crucial facts were concealed from the Tribunal.
• There was no commercial
purpose for applying the purchase method as all the companies are ultimately owned by the same parent company.
• The book profit on sale of share is computed as sales consideration minus book value. The book value
effectively was the sum of cost plus capital reserve (effectively as is in the case of revaluation reserve).
• Since the amount transferred to “capital reserve” actually qualified as “revaluation reserve,” upward adjustment to the book profit in terms of clause (j) of Explanation 1 to section 115JB of the Act was warranted.
Tribunal’s ruling
• The Revenue argued rhetorically but could not bring anything tangible on record to prove the scrumptious nature of the taxpayer to treat the Scheme as a sham. The motive of the tax evasion or the Scheme being a colourable device has not been proven by the Revenue.
• Because the land was in different group companies, consolidation thereof was the only way to get into the construction of any major project.
• Hence, the allegations of the Revenue about sham
transaction/ colourable device were dispensed with.
• The Revenue failed to appreciate that a revaluation reserve is created when an enterprise re-values its own existing assets. In the instant case, the taxpayer has not revalued its existing assets but recorded the fair values of various assets and liabilities acquired as its “cost of
acquisition” in terms of the court-approved Scheme and the provisions of AS-14.
• AS-10 permits upward revaluation of assets only in case of fixed assets. AS-13, which deals with investment, does not permit revaluation of its long-term investments at a value higher than the cost.
• Capital reserve, the difference between the amount of fair value of the net assets and the value of investment cancelled, recorded in case of merger in nature of purchase, cannot, by any stretch of argument, be regarded as “revaluation reserve.”
• Hence, the observation of the Revenue that the reserve created is in the nature of
“revaluation reserve” cannot be acceded to as it is in fact
“capital reserve.”
• Since capital reserve is out of the purview of section 115JB of the Act, and only the
revaluation reserve is considered for upward adjustment of the profit, the TO tried to bring the capital reserve to the fold of clause (j) of section 115JB of the Act [which deals with revaluation reserve]. This action of the TO cannot be sustained.
The takeaways
Capital reserve resulting from recording a scheme of
amalgamation under the
purchase method of accounting is not in the nature of revaluation reserve. Therefore, no adjustment under clause (j) to Explanation 1 to section 115JB of the Act is required for capital reserve.
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