Assessing Officers Tackle Section 47 Exemptions in Merger Reviews with New Guide

Merger Assessment Guide for Assessing Officers A Comprehensive Practical Framework for Income-tax Scrutiny

Introduction

Merger and amalgamation cases are unlike ordinary scrutiny assessments. In a normal case, the Assessing Officer examines income, expenses, deductions, and disallowances. In a merger case, however, the AO must first determine the legal character of the transaction itself. Only after that can the tax consequences be correctly understood.

A merger case may involve questions such as:

• whether a legally valid amalgamation has taken place,
• whether the conditions of Section 2(1B) are satisfied,
• whether capital gains exemption under Section 47 is available,
• whether goodwill has been created and tax depreciation wrongly claimed,
• whether brought forward losses or unabsorbed depreciation have been wrongly used,
• whether the transaction is in substance a slump sale rather than an amalgamation,
• whether inter-company loans give rise to deemed dividend issues,
• and whether the assessment is being framed in the correct name under Section 170.

This guide is intended as a practical, comprehensive ready-reckoner for Assessing Officers, especially in complex merger cases involving multiple group companies, large valuation adjustments, and significant tax computations.

1. Why merger assessments require a different approach

An amalgamation is not merely an accounting event. It is a legal restructuring event with tax consequences arising from:

• transfer of assets,
• assumption of liabilities,
• issue of shares,
• extinguishment of separate corporate identity,
• possible creation of goodwill,
• possible transfer of tax attributes like losses and depreciation.

Therefore, the AO should avoid two opposite mistakes: Mistake 1 — Over-suspicion Treating every merger as tax avoidance and making additions without first verifying the statutory structure. Mistake 2 — Mechanical acceptance Assuming that because the merger is approved by NCLT, all tax issues automatically stand resolved. The correct approach lies in between: First verify the legal nature of the transaction, then identify whether any tax benefit has been wrongly claimed.

2. The core legal framework an AO must keep in mind

Provision	Relevance
Section 2(1B)	Defines amalgamation
Section 47(vi)/(vii)	Capital gains exemption in qualifying amalgamations
Section 49	Cost of acquisition in hands of amalgamated company
Section 72A	Carry forward of losses and unabsorbed depreciation
Section 32	Depreciation, especially post-Finance Act 2021 goodwill issue
Section 170	Succession to business; correct assessee after amalgamation
Section 2(22)(e)	Possible deemed dividend issues from inter-company loans
Section 50B	Slump sale, where the transaction is not truly a tax-neutral amalgamation

The AO need not cite all these in every order, but must know which issue falls under which section.

3. Step 1 — Verify whether there is a legally effective merger

The first task is to establish whether a legally valid amalgamation has taken place.

The AO should call for and examine:

• certified copy of the NCLT order
• complete scheme of amalgamation
• details of the appointed date
• details of the effective date
• the names of all amalgamating and amalgamated companies

Why this matters

If there is no valid NCLT-approved scheme, the transaction may not be a merger at all. It may instead be:

• a business transfer,
• a slump sale,
• a share acquisition,
• or a mere internal accounting arrangement.

Illustration — no issue

Company A, Company B, and Company C merge into Company D pursuant to an NCLT order dated 15 January 2024. The scheme clearly provides that all three transferor companies are dissolved without winding up and all assets and liabilities vest in Company D.

In such a case, the AO may proceed on the basis that a legal amalgamation exists.

Illustration — issue

The assessee states that “group consolidation” has happened and files only internal board resolutions, but no NCLT order is produced. In such a case, the AO should not treat the transaction as tax-neutral amalgamation merely on the basis of description.

AO takeaway No NCLT order = no automatic assumption of amalgamation.

4. Step 2 — Test the conditions of Section 2(1B)

After establishing the legal existence of a merger, the AO must verify whether the transaction satisfies the tax-law definition of amalgamation under Section 2(1B).

The three conditions are:

1. All property of the amalgamating company becomes property of the amalgamated company
2. All liabilities of the amalgamating company become liabilities of the amalgamated company
3. Shareholders holding at least 75% in value of the shares of the amalgamating company become shareholders of the amalgamated company

These conditions are not mere formalities. If they are not satisfied, the capital gains exemption under Section 47 may fail.

4.1 How to verify transfer of assets

The AO should compare:

• balance sheet of each transferor company before merger
• opening post-merger balance sheet of the transferee company
• schedules of fixed assets, current assets, and investments

Illustration — no issue

Transferor Company A had:

• fixed assets = ₹10 crore
• current assets = ₹15 crore
• liabilities = ₹12 crore

After merger, the transferee’s books show increase in assets by ₹25 crore and liabilities by ₹12 crore.

This broadly matches the transferor’s position.

Illustration — issue

Transferor Company A had:

• fixed assets = ₹10 crore
• current assets = ₹15 crore
• liabilities = ₹12 crore

But the transferee books show only ₹18 crore assets and ₹5 crore liabilities taken over, with no explanation.

This indicates a possible failure of Section 2(1B), because all assets and liabilities may not have transferred.

4.2 How to verify shareholder continuity

This condition cannot be verified from the balance sheet alone. It must be checked from:

• shareholding pattern before merger
• share exchange ratio
• allotment details in transferee company

Illustration — no issue

Before merger, shareholders X, Y, and Z together held 82% of Transferor Company A. After merger, they receive shares in the transferee company and continue as shareholders.

Condition satisfied.

Illustration — issue

Before merger, X, Y, and Z held 90% of the transferor. After merger, only 35% of them remain as shareholders in the transferee and the rest are replaced by new shareholders.

This raises a serious issue under Section 2(1B).

AO takeaway A merger may look valid in company law and still fail Section 2(1B) for tax purposes.

5. Step 3 — Verify jurisdiction under Section 170

Once a merger becomes effective, the transferor company ceases to exist and the transferee becomes the successor.

The AO must ensure that assessment proceedings are taken in the name of the successor entity.

What to verify

• whether the transferor company has ceased to exist
• whether returns continue to be filed in the old name
• whether notices and final order are issued in the correct name

Illustration — no issue

The order is framed as: “ABC Pvt. Ltd., successor to X Ltd., Y Ltd., and Z Ltd. pursuant to amalgamation.”

No procedural issue arises.

Illustration — issue

The AO issues final order in the name of one of the dissolved transferor companies after the effective merger date.

This creates a jurisdictional defect.

AO takeaway Before discussing tax effect, always correct the assessee identity.

6. Step 4 — Examine capital gains neutrality under Section 47

If the merger satisfies Section 2(1B), the transfer of assets is generally not regarded as transfer under Section 47(vi), and shareholder exchange is protected under Section 47(vii), subject to statutory conditions.

The AO must verify:

• whether consideration is shares only
• whether any cash or non-share consideration was given
• whether the transferee is an Indian company where the statute so requires

Illustration — no issue

Transferor shareholders receive only shares of the transferee. No cash is paid. The transfer is pursuant to a qualifying amalgamation.

No capital gains addition arises.

Illustration — issue

Transferor shareholders receive shares plus ₹12 crore cash as balancing consideration.

The AO must then examine whether the exemption fully applies or whether taxable consequences arise.

AO takeaway Do not compute capital gains automatically just because assets moved. First ask whether the statute treats the movement as tax-neutral.

7. Step 5 — Examine Valuation and Share Exchange Ratio

In most merger schemes, the share exchange ratio between the amalgamating and amalgamated companies is determined on the basis of a valuation report prepared by an independent valuer.

The valuation report normally relies on one or more recognised valuation approaches such as:

• Net Asset Value (NAV) Method
• Discounted Cash Flow (DCF) Method
• Comparable Company Multiple Method

The Assessing Officer is not expected to conduct an independent valuation exercise. However, the AO should examine whether the valuation method used appears reasonable and consistent with the financial position of the companies involved, particularly where the valuation results in creation of substantial goodwill.

5.1 Net Asset Value (NAV) Method

Under the Net Asset Value method, the value of a company is determined based on the net value of its assets after deducting liabilities.

Illustration

Particulars	Amount
Land and Building	₹10 crore
Plant and Machinery	₹8 crore
Inventory	₹4 crore
Cash and Bank	₹3 crore
Total Assets	₹25 crore

Liabilities	Amount
Loans	₹10 crore
Creditors	₹5 crore
Total Liabilities	₹15 crore

Net Asset Value: ₹25 crore – ₹15 crore = ₹10 crore

Therefore, the value of the company under NAV method may be approximately ₹10 crore.

AO Perspective If the share consideration issued by the amalgamated company is close to this value, the valuation generally appears reasonable.

However, if shares worth ₹40 crore or ₹50 crore are issued for a company whose net assets are ₹10 crore, the AO may examine the basis of such valuation more closely.

5.2 Discounted Cash Flow (DCF) Method

The Discounted Cash Flow method values a company based on the present value of its expected future cash flows.

This method is commonly used where the company’s value lies more in its future earning potential than in its current assets.

Illustration

Year	Expected Cash Flow
Year 1	₹2 crore
Year 2	₹3 crore
Year 3	₹4 crore

Total projected cash flows = ₹9 crore

If these future cash flows are discounted to present value at a discount rate of 10%, the present value may be approximately ₹7.2 crore.

Thus the valuer may estimate the company’s value at around ₹7–8 crore.

AO Perspective DCF valuations depend heavily on future projections. Therefore, the AO should verify:

• whether projected revenues appear realistic
• whether growth assumptions are reasonable
• whether the discount rate used is appropriate.

Unrealistically optimistic projections may artificially inflate company value and lead to large goodwill creation.

5.3 Comparable Company Multiple Method

Under this approach, the company’s value is determined by comparing it with similar companies operating in the same industry.

Common valuation multiples include:

• Price-to-Earnings (P/E) ratio
• EV/EBITDA multiple
• Price-to-Sales ratio.

Illustration

Suppose listed pharma distribution companies trade at a P/E ratio of 20.

If the transferor company earns an annual profit of ₹5 crore, its value may be estimated as:

₹5 crore × 20 = ₹100 crore

AO Perspective The AO should verify:

• whether the selected comparable companies are truly similar
• whether the multiples used are consistent with industry averages.

5.4 Why Valuation Matters in Merger Assessments

Valuation itself rarely leads to a direct tax addition. However, valuation often determines the amount of goodwill arising from amalgamation.

Example:

Net assets acquired = ₹20 crore

Shares issued by transferee = ₹50 crore

Difference = ₹30 crore goodwill

If such goodwill subsequently leads to a tax deduction (for example, through depreciation claims), the AO must verify whether such deduction is permissible under law.

After the amendment made by the Finance Act 2021, goodwill of business or profession is no longer eligible for depreciation under Section 32.

Therefore, while goodwill may legitimately arise from valuation differences, the AO should verify whether the assessee has claimed any tax depreciation on such goodwill.

Practical AO Rule In merger assessments, valuation becomes relevant mainly when it results in:

• unusually large goodwill,
• tax deductions linked to that goodwill,
• or share exchange ratios that appear commercially unreasonable.

If the valuation appears reasonable and no tax benefit has been claimed based on it, the Assessing Officer normally need not disturb the valuation.

8. Step 6 — Goodwill verification and depreciation after Finance Act 2021

This is often the most discussed issue in merger assessments.

Goodwill may arise when consideration exceeds net assets taken over.

Formula Consideration – Net assets = Goodwill

Illustration

Net assets acquired = ₹50 crore

Shares issued = ₹55 crore

Goodwill = ₹5 crore

Goodwill in books does not automatically mean tax addition.

The AO must ask: Has the assessee reduced taxable income by claiming depreciation on goodwill?

After the Finance Act 2021, goodwill of business or profession is no longer a depreciable asset for tax purposes.

8.1 The AO’s three-document test for goodwill

The AO must read together:

1. Books of account — does goodwill exist?
2. Income-tax depreciation schedule — is goodwill in the tax block?
3. Computation of income — has goodwill depreciation reduced taxable income?

Illustration — no addition

Goodwill appears in books, but:

• book depreciation is added back,
• tax depreciation schedule does not claim goodwill depreciation,
• no reduction in taxable income occurs on this account.

Then no addition arises.

Illustration — addition

Goodwill of ₹40 crore is created and tax depreciation of ₹10 crore is claimed in IT depreciation schedule. The computation deducts that depreciation.

Since goodwill depreciation is not allowable post-amendment, ₹10 crore must be disallowed.

AO takeaway Goodwill existence is not the issue. Goodwill tax depreciation is the issue.

9. Step 7 — Carry forward of losses and unabsorbed depreciation

When the amalgamated company claims brought forward losses or unabsorbed depreciation, the AO must first determine whose tax attribute is being used.

First distinction

• if losses belong to the transferee company itself, the issue may be ordinary carry forward
• if losses belong to the transferor company, then Section 72A becomes relevant

Illustration — no issue

ABC Pvt Ltd claims ₹5.68 crore of brought forward loss. On verification, this is ABC Pvt Ltd’s own loss from earlier years.

No Section 72A issue.

Illustration — issue

ABC Pvt Ltd claims ₹12 crore of brought forward loss, but it actually belongs to transferor companies. No evidence of compliance with Section 72A is filed.

Then the set-off cannot be allowed automatically.

9.1 What to verify under Section 72A

The AO should verify:

• whether the transferor companies had eligible business
• whether business is continued after merger
• whether statutory conditions and prescribed requirements are satisfied

Illustration — allowable

Transferor company had manufacturing loss of ₹8 crore. After merger, the same manufacturing business continues, assets are retained, and statutory conditions are met.

Loss can be considered.

Illustration — disallowable

Transferor had ₹8 crore loss. Immediately after merger, business is discontinued and key assets are sold.

Loss carry forward may fail.

AO takeaway Merging a loss company into a profit company does not automatically transfer tax benefit.

10. Step 8 — Inter-company loans and Section 2(22)(e)

Merger cases often involve multiple group companies with inter-company balances. The AO must examine whether any of those balances create a deemed dividend issue.

Illustration — no issue

Company A gives Company B a trade advance for inventory procurement, fully connected to business operations.

No deemed dividend issue.

Illustration — issue

Closely held Company A gives ₹5 crore loan to Company B. A common shareholder has required voting power in A and substantial interest in B, and accumulated profits exist.

This may attract Section 2(22)(e), subject to correct legal analysis of taxable person.

AO takeaway Merger itself is not deemed dividend. Pre-merger loan structure may still need verification.

11. Step 9 — Slump sale vs amalgamation

A recurring confusion in merger cases is whether the transaction is actually a slump sale under Section 50B.

The AO should examine:

• whether the entire company is amalgamated
• or whether only a business undertaking is transferred
• whether consideration is shares or lump sum cash

Illustration — no issue

All 19 companies merge into the transferee under NCLT scheme and shareholders receive shares.

This is classic amalgamation, not slump sale.

Illustration — issue

One pharma division of a company is transferred to another entity for ₹100 crore cash under a business transfer agreement.

This is more in the nature of slump sale.

AO takeaway Internal use of words like “slump adjustment” in books does not by itself create a Section 50B case. Look at legal structure and consideration.

12. Step 10 — Reconcile return, original computation, and revised computation

This is one of the most practical areas where additions arise.

Assessees sometimes file a revised computation during scrutiny admitting that certain income was wrongly excluded.

The AO must verify whether that corrected income is already reflected in the return on record.

Illustration — no addition

Original computation: ₹172.68 crore

Revised computation: ₹173.97 crore

ITR / revised filing already reflects ₹173.97 crore

Then no separate addition is needed.

Illustration — addition

Original computation: ₹172.68 crore

Revised computation filed during assessment: ₹173.97 crore

But return on record still reflects ₹172.68 crore

Then the AO should assess ₹173.97 crore. The difference becomes assessable.

AO takeaway A revised computation during scrutiny does not by itself alter the return figure. The AO must assess correct income.

13. Common red flags in merger assessments

The following features warrant closer scrutiny:

• merger of multiple loss-making entities without clear commercial purpose
• large valuation differences creating substantial goodwill
• immediate post-merger sale of key assets
• partial transfer of assets or liabilities
• cash component in what is claimed to be a tax-neutral merger
• unexplained inter-company loan balances
• mismatch between NCLT scheme, books, and tax computation

A red flag does not automatically justify an addition, but it does justify deeper verification.

14. The AO’s practical decision rule

A merger assessment should end in one of two ways:

No addition When:

• legal merger exists
• Section 2(1B) conditions are satisfied
• no wrongful goodwill depreciation claimed
• no impermissible loss transfer
• no slump sale or deemed dividend issue
• computation on record matches the correct income

Specific addition When:

• goodwill depreciation is claimed in violation of law
• transferor losses are wrongly set off
• corrected income admitted by assessee is not reflected in the return
• cash/lump sum structure changes the tax character
• pre-merger loan structure attracts tax consequences

15. Final conclusion for Assessing Officers

The AO should remember one central principle:

A merger case is not an addition-oriented case by default; it is a verification-oriented case.

The object is to identify whether the assessee has obtained any tax benefit not permitted by law. If the transaction is legally valid, tax-neutral conditions are satisfied, and no excess deduction or set-off is claimed, the returned income may be accepted.

A sound merger assessment is one where:

• legal structure,
• accounting treatment, and
• tax computation

all reconcile with one another.

That is the hallmark of a sustainable assessment.