Intra-Group Transfer of Shares to Wholly Owned Subsidiary

Intra-Group Transfer of Shares to Wholly Owned Subsidiary Exempt From Capital Gains Under Section 47(iv)

Issue

Whether a French-based parent company’s transfer of 100% shares of an Indian subsidiary to another wholly owned Indian subsidiary constitutes a valid, tax-exempt capital asset reorganization under Section 47(iv) of the Income-tax Act, 1961, or whether it can be recharacterized by the Assessing Officer as revenue income from other sources on the grounds of a short holding period for a portion of the shares.

Facts

The assessee is a company based in France that held a 60% stake in an Indian company, VSIPL, since the year 2012.
Following the failure of a joint venture, the assessee acquired the remaining 40% stake in VSIPL from its JV partner in 2018, thereby becoming the 100% owner.
In December 2019, the assessee sold 100% of its shares in VSIPL to another of its wholly owned Indian subsidiaries, VIPL, and claimed a tax exemption under Section 47(iv).
Subsequent to this share transfer, VSIPL was merged into VIPL through a court-sanctioned fast-track merger process.
The Assessing Officer (AO) disallowed the exemption, treating the entire transaction as a trade venture rather than a capital asset transfer because the final 40% stake was acquired in 2018 and sold shortly after in 2019.
Consequently, the AO treated the entire sale consideration as “Income from other sources”.

Decision

Held, yes: The transaction represented a internal corporate reorganization of shareholding with zero change in ultimate beneficial ownership, preserving the continuity of economic interest while ensuring the capital asset remained within India.
Held, yes: In the absence of any material showing that the transaction was circular, self-cancelling, or devoid of economic substance, the arrangement cannot be disregarded by the revenue authority purely on a perceived tax advantage.
Held, yes: The transaction is a bona fide transfer completely protected by the corporate restructuring exemptions under Section 47(iv), and the income tax addition made by the Assessing Officer is ordered to be deleted [In favour of assessee].

Key Takeaways

No Change in Ultimate Ownership: Internal transfers of shares between a parent company and its 100% owned subsidiaries do not alter the ultimate economic control, meaning they qualify as non-taxable internal restructurings under Section 47(iv).
Holding Period Does Not Reset Intent: The brief holding period of a subsequently acquired block of shares (the 40% stake) does not automatically convert a long-term capital investment into a business trading venture.
Legitimacy of Tax Planning: Commercial reorganizations—including subsequent corporate mergers—cannot be branded as tax avoidance schemes unless the tax department provides clear evidence of a sham, circular, or self-cancelling layout.

K. Prasanna, Adv. for the Appellant. M. Murali, CIT for the Respondent.

ORDER

Ms. Padmavathy S., Accountant Member. – This appeal by the assessee is against the final order of assessment passed by the Asst. Commissioner of Income Tax, International Circle-2(2), Chennai (in short “A.O”) passed u/s. 143(3) r.w.s 144C(13) of the Income Tax Act, 1961 (in short “the Act”) dated 13.07.2023 for Assessment Year (AY) 2020-21. The grounds of appeal raised by the assessee are as under:

“1. General Ground

1.1 The Ld. DCIT and Ld. DRP erred in law by not giving sufficient opportunity to the Appellant, thereby violating the principles of natural justice.

2. Questioning the Commercial Expediency of the transaction

2.1 The Ld. DCIT and Ld. DRP has questioned the choice of implementation of the option by questioning the commercial expediency of the transaction, thereby, stepping into the shoes of a businessman to decide on the reasonableness and justification of a business transaction.

2.2 The Ld. DCIT and Ld. DRP rejected the arguments of the Appellant by placing an alternate method of implementing the transaction.

2.3 The Ld. DCIT and Ld. DRP has not considered the fact/ explanations provided by the Appellant during the proceedings with respect to the rationale for the acquisition of the remaining shares of Valeo Service India Auto Parts Private Limited (VSIAPL’).

3. Erroneous interpretation of intent test

3.1 The Ld. DCIT and Ld. DRP erred in law and on the facts of the case by wrongly applying the intent test to consider the shares held by the Appellant in its subsidiary VSIAPL as stock-in-trade instead of capital asset. Consequently, treating the entire consideration for the sale of shares as ‘other Income’.

3.2 The Ld. DCIT and Ld. DRP has failed to appreciate the fact that the Appellant held 60% of the shares of VSAIPL right from its incorporation and has taken a narrow interpretation in characterizing the investment.

3.3 The Ld. DCIT and Ld. DRP failed to appreciate the circular issued by CBDT in the characterization of shares.

4. Denying the benefit of Section 47(iv) of the Act

4.1 The Ld. DCIT and Ld. DRP has erred in law by not understanding the facts of the case and thereby denying the benefit of the provisions of Section 47(iv) of the Act.

5. Not applied the provisions of the tax treaty between India and France

5.1 Notwithstanding the above, the Ld. DCIT and Ld. DRP had erred in law and facts in concluding that the income is accrued in India, without appreciating the actual facts and, to the extent has not applied the provisions of the Tax Treaty between India and France.

5.2 The Ld. DCIT and Ld. DRP failed to appreciate the law that the purpose of Section 9(1)(i) is only to shift the locale of accrual to India based on situs of shares and such deeming fiction cannot be imported to DTAA.

6. Deduction of cost of acquisition

6.1 The Ld. DCIT and Ld. DRP failed to allow the cost of acquisition of shares as a deduction under Section 57 of the Act.

7. The Ld. DCIT erred in levying interest under 234A, 2348 of the Act and initiated penalty under 270A of the Act, which are consequential in nature.

8. The Appellant craves leave to add, alter, vary, omit, amend or delete one or more of the above grounds of appeal at any time before, or at the time of, hearing of the appeal.”

2. The assessee is a tax resident of France and does not carry out any business operation in India. The assessee has made several investments in operating group entities around the world. The assessee has made investments in the following entities in India:

Valeo India Pvt. Ltd. (VIPL) – 100%

Valeo Service India Auto Parts Pvt. Ltd. (VSIAPL) – 99.98%

3. The assessee for the AY 2020-21 filed the return of income on 12.02.2021 admitting total income of Rs.15,42,11,900/- and claimed refund amounting to Rs. 6,15,20,120/-. The case was selected for scrutiny and the statutory notices were duly served on the assessee. During the course of assessment, the A.O called on the assessee to the reasons for the claiming refund. The assessee submitted that during the year under consideration, the assessee has sold its shares in the VSIAPL to VIPL for a consideration of Rs. 64,78,01,960/-and that at the time of payment of consideration VIPL has deducted tax at source for Rs. 6,01,78,155/-. The assessee further submitted that the impugned transaction of sale of shares is not to be treated as transfer under the provisions of section 47(iv) of the Act and therefore the said transaction resulted in the claim of refund in the return of income. The A.O called on the assessee to furnish further details and also to show cause as to why the impugned transaction is not subjected to tax in India. The assessee furnished various details giving the background of the transactions and also the reasons as to why the transaction cannot be charged to tax in India under the Act. The A.O however did not accept the submissions of the assessee and proceeded to treat the entire consideration as income from other sources. Aggrieved by the draft assessment order passed by the A.O, the assessee filed objections before the Disputes Resolution Panel (DRP), who confirmed the addition made by the A.O. The A.O passed the final assessment order as per directions of the DRP and the relevant findings of the A.O in this regard are extracted herein below:

“a)

In its reply, the assessee has said that “transaction relating to the merger of VSIAPL and VIPL is not a subject of assessment”. It is to be noted that there was an option to avoid the purchase of the shares of VSIAPL by VIPL from the assessee company, but the assessee company choose to go ahead with the sale of the shares. Therefore, the contention of the assessee in this regard is rejected.

(b)

Further, the assessee had stated that “the approval of NCLT takes anytime between 9 months to 18 months minimum depending on the complexity and procedure followed by respective NCLT. Whereas a fast track merger involves placing of Scheme before Regional Director, Registrar of Companies (‘ROC’), Liquidator etc to invite objections. The objections and suggestions received by the companies should be considered in the respective general meetings and shareholders must approve the Scheme at the general meetings holding at least 90 percent in value and creditors representing nine-tenths of debt in value. The objections to scheme, if any, are invited from Registrar of Companies, Reserve Bank of India, Official Liquidator, and Income-tax Authorities. If there is no objection, the Scheme will be approved. However, the assessee company failed to submit the reason on to how the fast track process would be beneficial for the group apart from the fact that the alleged non-taxable funds being received from their Indian Subsidiary as remittances. Further, no objections were invited from Income Tax Authorities and the same has not been substantiated by the assessee company in their submissions. Also, no proper justification was provided during the course of hearing on to why the Indian entity M/s. VIPL would purchase the shares of M/s. VSIAPL from the assessee company with it having to pay an amount of Rs. 64,78,01,980 incurring the huge fall in its cash flow, where the same could have been avoided with the merger process as stipulated in sections 230-232 of the Companies Act, 2013.

(c)

The assessee has given the details of its exit from the JV by purchasing shares from Anand Group and stated that the 40% stake held by Anand Group for INR 55/share. However, within a period of 18 months the share value has been increased to INR 72.01/share, thereby increasing the net asset value by Rs. 15.30 crores with a meagre increase in profits during that period. Further in its own valuation report, the assessee company has done the valuation based on the calculation of Net Asset Value Method and based on Discounted Cash Flow Method. The value per share as per the Net Asset Value Method is at INR 38.67 per share (INR 348053000/9000000 shares), however, the value per share as per the Discounted Cash Flow Method is at INR 72.01 per share. The assessee company has considered the valuation as per the Discounted Cash Flow Method which is based on projections. Therefore, it can be seen that the company (M/s. VSIAPL) which was already planned to be merged/amalgamated with M/s. VIPL and thereby extinguishing the shares of M/s. VSIAPL after merger/amalgamation, was valued at the beneficial rate per share only to transfer the consideration received against the sale of shares of M/s. VSIAPL to the assessee company M/s. VBF, when the merger/amalgamation could have happened without sale of shares of M/s. VSIAPL.

(d)

The assessee company has stated that “the object of the investment in shares of a company is to derive income by way of dividend etc., then the profits accruing by change in such investment (by sales of shares) will yield capital gain and not revenue receipt”. However, in the instant case as per the assessee, the motive of the assessee company was not to accrue any profit or yield but only to enable fast track merger of M/s. VSIAPL with M/s. VIPL. Thus, the nature of remittances received are revenue in nature but not capital. Further as per “Part C Consideration for Amalgamation” of the Scheme of Amalgamation, it has been stated that “all Equity Shares, held by the Transferee Company and its nominees in the Transferor Company, shall be cancelled and extinguished” establishing the fact that there was no object of the investment by the assessee company to derive income by way of capital gains. Therefore, it is apparent that the income received by the assessee company is revenue in nature and clearly forms part of the other income.

(e)

The assessee company in its reply stated that “shares held in VSIAPL is only a capital asset and any gain made cannot be assessed as ‘other income.” Further the assessee had relied upon several case laws where the facts are circumstances of those are different to that of the instant case.

6. Conclusion:

Thus, in the instant case the shares of M/s. VSIAPL purchased by the assessee company M/s. VBF was not mandatory or beneficial apart from the fact that the assessee company M/s. VBF is receiving remittances to tune of Rs.64,78,01,960. The reason stated by the assessee company where in the transfer of shares was done to utilise the provisions of section 233 of the Companies Act, 2013 is redundant on account that there are other provisions available in Companies Act, 2013 through which the merger/amalgamation could have happened without having to transfer the shares of M/s. VSIAPL and in lieu of the same the assessee company received Rs. 64,78,01,960 towards sale consideration. Even here the assessee adopted a higher value per share using Discounted Cash Flow Method which is based on projections of the company M/s. VSIAPL which is no longer going to exist after the merger (Valuation through DCF method is INR 72.01 per share and Valuation through NAV Method is INR 38.67 per share).”

4. The assessee is in appeal before the Tribunal against the final order of assessment passed by the A.O.

5. The brief facts pertaining to the impugned issue as submitted by the assessee is extracted below –

•

VSIAPL was a joint venture (JV) between the Appellant and Asia Investment Private Limited (“AIPL”) (an entity of Anand Group), and it was engaged in aftermarket trading of Valeo and Anand Group automotive parts.

•

The objective of the JV was not realised; hence, the parties mutually exited the JV. The Appellant subsequently acquired the 40% stake held by AIPL on 26 June 2018. The consideration was agreed at INR 55 per share (approx.) A copy of the share purchase agreement was entered into by the parties to give effect to this exit. [Refer to Page 84 of Paper Book]

•

Following the acquisition of a 40% stake in AIPL, VSIAPL’s shares were held by the Appellant along with its nominees. The details of investment made in VSIAPL by the Appellant are tabulated below:

#	Particulars	Number of shares	Year of infusion/ acquisition
1	Capital infusion by Valeo Bayen	42,00,000	2012
2	Capital infusion by Valeo Bayen	12,00,000	2014
3	Purchase of shares by Valeo Bayen from AIPL	35,96,000	2018

•

The shareholding in VIPL and VSIAPL was classified as investment in subsidiaries and affiliates as part of long-term financial assets. A copy of the financial statement evidencing the same is available at Pages 176, 177 and 186 of the paperbook. From the Appellant’s Financial Statements, it can also be noted that it held these investments on a long-term basis and not as stock-in-trade, and that it did not engage in trading in shares or securities.

•

The Appellant had held its stake in VSIAPL till 22 December 2019. Both VIPL and VSIAPL were operating in parallel until 22 December 2019.

•

On 23 December 2019, the Appellant has sold the shares of VSIAPL to VIPL for a consideration of INR 64,78,01,960. Following the acquisition of the shares from the Appellant, VSIAPL was merged with VIPL under the fast-track merger process under the Companies Act 2013.

•

The period of Holding of the stakes in VSIAPL was tabulated below:

#	Particulars	Number of shares	Year of acquisition	Year of Sale	Period Held	Classification of Asset
1	Capital infusion by Appellant	42,00,000	March 2012	Dec 2019	94 Months	Long Term
2	Capital infusion by Appellant	12,00,000	September 2014		64 Months	Long Term
3	Purchase of shares by Appellant from AIPL	35,96,000	June 2018		18 Months	Short Term

•

Since the capital assets (as classified by the Appellant) were sold to VIPL (WOS), the Appellant claimed that transfer of shares cannot be regarded as transfer by virtue of Section 47(iv) of the Income-tax Act, 1961(‘the Act’). Accordingly, it availed the exemption provided under the Act and claimed refund of taxes withheld by VIPL at the time of discharge of consideration.

6. The Ld. AR submitted that the A.O has considered a subsequent event i.e., merger between VSIAPL and VIPL to come to the conclusion that the impugned transactions are undertaken to avoid tax which is not correct. The Ld. AR argued that they are two independent transactions and the sale of shares by the assessee prior to merger was done for commercial expediency to avoid the delay in the process of merger which cannot be viewed from the lens of tax avoidance. The Ld. AR further argued that the A.O’s observation that there was an option available to avoid the purchase of shares of VSIAPL by VIPL but the assessee chose to go ahead with sale of shares is not correct since the assessee has entered into the sale transaction to fast track the merger u/s. 233 of the Companies Act, 2013 and not to avoid tax liability. The Ld. AR also argued that the way a particular transaction has to be carried out is at the option of the assessee who is running the business and the tax authorities cannot interfere with the choice of the taxpayer. The Ld. AR submitted that the assessee has sold the shares and the said transaction is carried out within the four walls of tax law and cannot therefore be held to be abusing of the provisions of the Act. The Ld. AR further submitted that merely because a transaction is claimed to be not taxable as per the provisions of the Act the Revenue cannot question the genuineness of the transaction without any evidence. The ld. AR also submitted that the A.O has treated the consideration received by the assessee as income from other sources without considering the fact that the shares of VSIPL held by the assessee are in the nature of capital asset the transfer of which if at all is taxable need to be brought to tax under the head “capital gains”. The Ld. AR drew our attention to the fact that the assessee was holding 60% of the shares of VSIPL since March, 2012 and that the balance 40% was purchased from Asia Investment Pvt. Ltd. with whom the assessee has entered into a joint venture. The Ld. AR submitted that the A.O while making the addition has completely ignored the facts submitted by the assessee with regard to the impugned transactions and has held the same as adventure in the nature of trade though he proceeded to make the addition under head “income from other sources”. The ld. AR further submitted that the impugned transactions are clearly covered under the provisions of Section 47(iv) of the Act and therefore, the claim of the assessee cannot be denied merely because the same is exempt.

7. We have heard the parties, and perused the material available on record. The assessee is a French company and was holding 60% of shares in VSIPL since 2012 and the other 40% was held by assessee’s JV partner. Since the JV did not materialise, the assessee bought the 40% shares of VSIPL from its JV partner in 2018 for a price of Rs.55 per share whereby VSIPL became its 100% subsidiary. The assessee during the year under consideration sold 100% of its holding in VSIPL to another wholly owned subsidiary VIPL for a consideration of Rs. 64,78,01,960/-. Subsequently, VSIPL got merged with VIPL. The contention of the revenue is that impugned transaction is in the nature of trade and that the assessee has carried out the transaction to remit the consideration without paying tax. The revenue further contents that the assessee has not provided proper explanation for selling the shares of VSIPL that could have been done by a merger which the assessee carried out subsequently. The revenue also contents that since the assessee has acquired the assets only in the year 2018 to sell it in 2019, the intention is not to hold it as capital asset and hence the consideration received is income from other sources. We have considered the written submissions of the Ld AR, the arguments during the course of hearing and the case laws relied on which is submitted in the form of a paper that have been taken on record.

8. The primary issue for consideration is whether the transfer of shares by the assessee to its wholly owned subsidiary constitutes a colourable device to avoid tax. One of the contentions of the AO is that the shares of VSIPL are not capital assets, we notice on perusal of facts that the assessee had acquired major portion of shares (60%) in VSIAPL since 2012 and the same is held as an investment and not as stock-in-trade. The acquisition of balance shareholding (40%) in 2018 pursuant to exit of JV partner and the subsequent transfer in 2019 is considered by the revenue as transaction in the nature of trade. In our considered view, the said contention of the revenue has not considered the transaction as whole i.e. the earlier holding of the assessee and has been decided merely based on the subsequent acquisition. In absence of any material to establish sham or lack of commercial substance, the transaction cannot be disregarded merely because it results in tax benefit. The settled position of law is that tax planning within the framework of law is permissible. The AO has questioned the necessity of share transfer vis-a-vis merger i.e. why the assessee has chosen the fast track merger u/s.233 of the companies Act instead of the normal merger and that AO has treated the transaction as non genuine for the reason that the assessee could not substantiate the action with proper evidence. It is well settled that Revenue cannot sit in the armchair of a businessman and dictate the manner in which business decisions are to be taken. In the present case, the decision to sell the shares and subsequently merge the wholly owned subsidiaries according to the assessee is based on commercial expediency and the revenue cannot question the authenticity of the transaction for the only reason that the assessee has received consideration without paying taxes as per the provisions of the Act. Accordingly we are unable to agree with, the observations of the AO on alternate modes of merger not explored by the assessee as a reason for making the impugned addition.

9. During the course of hearing, the ld DR drew our attention to the financial statements of VIPL post merger to submit that the disclosure whereby the VSIPL shares are cancelled and extinguished and that a substantial sum being transferred to capital reserve goes to prove that the assessee has carried out the transaction for the purpose of moving funds out of India without making any payment towards tax. In this regard, we notice that financial disclosure by VIPL post merger is accounting disclosure where the net assets of VSIPL being more than the consideration paid is adjusted against capital reserve. The words “cancelled and extinguished” is used since the shares of VSIPL post merger would become shares of VIPL and since VIPL cannot hold its own shares, the shares of VSIPL would automatically get cancelled and extinguished. Further the accounting treatment and disclosures as per accounting standards cannot be the basis for treating the transaction as non-genuine and that too disclosure made in the Indian subsidiary of the assessee. The revenue, otherwise has not recorded anything with regard to the impugned transaction as how the same is in violation of the provisions of the Act and how the exemption claimed is not allowable under the Act.

10. The revenue’s ground for denial of exemption u/s.47(iv) is that the shares of VSIPL transferred by the assessee are not capital asset within the definition of section 2(47). The assessee has been holding the major portion of shares of VSIPL as investments since 2012 and the deciding the nature of asset as trading asset solely based on subsequent acquisition of 40% without holistic examination of intention and conduct of the assessee as already held is not tenable. Therefore in our view once the asset is a capital asset there is no reason to question the applicability of section 47(iv) and the real test would then be whether the assessee has rightly claimed the exemption. Section 47(iv) of the Act provides that a transfer of a capital asset by a holding company to its wholly owned subsidiary shall not be regarded as a transfer provided the following conditions are satisfied –

•

The Holding Company or its nominees has to hold whole of the share capital of the subsidiary company, and

•

The subsidiary company is an Indian Company

11. In assessee’s it is not in dispute that the assessee holds 100% shares in VSIPL and VIPL and that both these companies are Indian companies. Accordingly we see no reason to deny the exemption as claimed by the assessee. With regard to the valuation of shares of VSIPL which is doubted by the AO we notice the valuation report is rejected by mere comparison with NAV and the AO has not recorded any defects in DCF methodology adopted by the assessee. The assessee has the statutory right to select either the DCF or NAV method and the AO has the power to examine the valuation report and question the assumptions. It is a settled position that the AO cannot reject the valuation report without pointing out specific defects or inaccuracies in the report. From the perusal of records we notice that the AO has not called on the assessee to furnish any details pertaining to the valuation and has not recorded any defects with regard to projections etc. Therefore in our considered view the allegation regarding undervaluation or beneficial pricing lacks merit.

12. As regards the tax advantage arising from the impugned transaction, it is observed that the existence of a tax benefit, by itself, cannot lead to the conclusion that the transaction is impermissible, unless it is demonstrated that the arrangement lacks commercial substance or is carried out in a non-genuine manner. In the present case, the impugned transaction results in a reorganization of shareholding without any change in the ultimate beneficial ownership, thereby indicating continuity of economic interest where the capital asset continue to exist is India. Further, there is no material to suggest that the transaction is circular, self-cancelling, or devoid of real economic effect. In the absence of any finding that the arrangement results in misuse or abuse of the provisions of the Act, or that it lacks economic or commercial substance, the transaction cannot be disregarded merely on the basis of perceived tax advantage. In view of the above, we hold that the impugned transaction is a bona fide transfer squarely covered by Section 47(iv). Accordingly, the exemption claimed by the assessee is upheld and the addition made by the AO is directed to be deleted.

13. In result, the appeal of the assessee is allowed.