Sec 56 of the LLP Act provides for conversion from private limited company into limited liability partnership.  Third schedule of the LLP Act deals with procedure and effect of conversion of private limited company into LLP.  On conversion, whole of the undertaking of the company shall be transferred to and shall vest in the limited liability partnership without further assurance, act or deed.

In the context of such conversion, the issues have come before courts, as to whether conversion is transfer for the purpose of income tax and how should the capital gains computation be done in such cases.  Also Courts have dealt with the issue of arising from interpretation of section 47(xiiib) of the Act.

ACIT v Celerity Power LLP (2018) 100 129 (Mum ITAT)

The assessee was engaged in the business of power generation. In the revised return of income, the assessee showed NIL income after claiming the set off of brought forward loss of Rs. 5.80 crores.  Subsequently, the return was selected for scrutiny wherein the AO noted that assessee had acquired the status of a LLP on 28-9-2010 and the entire business, assets and liabilities of the erstwhile Company, Celerity Power Pvt. Ltd. were transferred to the assessee.

The AO rejected the assessee’s contention that the conversion of the company into LLP did not involve any transfer of the property, assets, liabilities etc and that the capital gains, if any, could only be brought to tax in the hands of the erstwhile company.  On estimation basis an amount of Rs. 1.76 crores was added to the total income of the assessee as ‘capital gains’ under section 47A(4).  Further, the claim of the assessee as regards ‘carry forward’ of depreciation loss of the erstwhile company was also rejected by the AO.

The CIT(A) held that there was a transfer by virtue of the provisions of section 47(xiiib). However, since the difference between the transfer value and the cost of acquisition was Nil, the machinery provision contemplated in section 48 for computing the capital gains was rendered as unworkable.  The CIT(A) also rejected the claim of carry forward the losses.

The ITAT observed that section 47 provides ‘transfers’ referred to in the said provision would not be chargeable to income-tax under the head “Çapital gains” under Sec. 45 of the Act if certain conditions are satisfied.  The ITAT therefore concluded that transactions referred to in Sec. 47 are ‘transfers’ and would be exempt if conditions are satisfied. Since, in the instant case, assessee has failed to satisfy conditions laid down in proviso to clause (xiiib) of section 47, the transaction of conversion of Company into LLP is ‘transfer’.

The ITAT rejected the contention of the Assessee that conversion is not ‘transfer’.  The Assessee had relied on Clause 6(b) of the ‘Third Schedule’ of LLP Act, which provided that all tangible (movable or immovable) and intangible property vested in the company, all assets, interests, rights, privileges, liabilities, obligations relating to the company and the whole of the undertaking of the company shall be transferred to and shall vest in the limited liability partnership without further assurance, act or deed. 

Referring to definition of ‘Convert’ in Clause 1(b) of the ‘Third Schedule’ of LLP Act, the Tribunal held that “On a perusal of the definition of the term “convert”, it can safely be gathered that the conversion of a private company into a LLP involves transfer of the property, assets etc.”.  Further, referring to section 575 of Companies Act, 1956, the Tribunal also observed that “it can safely be concluded that conversion of a company into a LLP as in the case before us, is differently placed as in comparison to succession of a partnership firm by a company under Part IX of the Companies Act, 1956”.

The Tribunal held that section 47A(4) comes into play only for purpose of withdrawing an exemption earlier availed by an assessee under section 47(xiiib) and cannot be invoked to tax capital gains on conversion of Company into LLP in the hands of LLP.  The ITAT further held that capital gains involved in transfer of capital assets on conversion of private limited company to assessee LLP, de hors applicability of section 47A(4), would be subject to liability of assessee LLP (as a successor entity) as per the provisions of section 170(2) read with Explanation thereunder.

Relying on two judgments of the Hon’ble Supreme Court viz. CIT v. George Henderson and Co. Ltd. [1967] 66 ITR 622 and CIT v. Gillanders Arbuthnot and Co. [1973] 87 ITR 407 (SC), the Tribunal held that ‘full value of consideration’ used in Sec. 48 cannot be construed as the ‘market value’ of the asset on the date of transfer.  The ITAT held that upon conversion of a private limited company into assessee-LLP, entire undertaking of erstwhile company got vested into assessee-LLP at book value, and therefore book value was to be regarded as full value of consideration for purpose of computation of capital gains under section 48.  The ITAT held that that Market value cannot be adopted for capital gains computation.  The ITAT further observed that as per section 49(1)(iii), where capital assets become property of assessee by succession, inheritance or devolution, cost of acquisition of assets shall be deemed to be cost for which previous owner of property had acquired same.  The ITAT finally concluded that though there was a transfer of capital assets from the erstwhile private limited company to the assessee LLP by virtue of the provisions of Sec. 47(xiiib), however, as the difference between the transfer value and the cost of acquisition was Nil, therefore, while computing the ‘capital gains’ the machinery provision was rendered as unworkable.”

With respect to carry forward of losses, the ITAT held that assessee had failed to satisfy conditions laid down in proviso to clause (xiiib) of section 47, and therefore CIT(A) rightly declined ‘carry forward’ of losses of erstwhile company by assessee LLP.

Aravali Polymers LLP v JCIT (2014) 47 335 (Kolkatta Tribunal) – Aravali Polymers Pvt. Ltd. was converted into Assessee LLP.  The main assets in the Pvt Ltd company was 31,80,000 shares of East India Hotels Ltd.  After conversion into LLP, the equity shares of the East India Hotels Ltd were sold by the LLP for Rs.53.56 crores and the same was offered for taxation as long-term capital gains.  The LLP gave an amount of Rs.50 crores as interest free loans to the partners of the LLP.  The Assessee had also claimed exemption under section 47(xiiib).  The AO held that since interest free loan was given, there was violation of condition of section 47(xiiib) and applying provisions of section 47A(4), the AO held that the amount of profit and gains arising from the transfer of the capital assets or shares is to be profit and gains chargeable to tax on the assessee firm being the successor LLP.  The AO adopted market value of shares to compute the taxable capital gains. 

The ITAT observed that a reading of the proviso (c) to section 47(xiiib) gives a meaning that both the Company and the LLP must exist for the shareholders of the Company to receive any consideration.  The ITAT held that since the Company does not exist after conversion, therefore, the question of a violation of Proviso (c) to Section 47(xiiib) does not arise.

With respect to interest free loan partly paid out of reserves, the ITAT held that “The fact that the loan has been paid, it is an interest free loan coupled with the fact that the loan has been given to its partners in the same rat io as profit sharing shows that the amount has been given directly to the partners out of the balance of the accumulated profits standing in the accounts of the Company on the date of conversion.  It clearly shows that there is a violation of proviso (f) to sect ion 47(xiiib).  Proviso (f) of section 47(xiiib) having been violated the benefit of the provisions of section 47, which deems certain transactions to be not regarded as transfer stands violated.”

With respect to applicability of section 47A(4), the ITAT held that since conditions prescribed for the benefit of sect ion 47(xiiib) were not complied with in the year of conversion itself and therefore question of applying section 47A(4) does not arise.

With respect to computation of Capital Gains, the ITAT held that “The value at which the shares or the assets of the Company Aravali Polymers Pvt. Ltd. was taken over by the LLP, would be the sale price and the cost of acquisition thereof is to be as per books of the erstwhile Company.  In these circumstances, the issue of computation of the capital gains under section 45 is restored to the file of the Assessing Officer, who shall take the sale consideration as on 12.10.2010 at the figure, at which the assets of the erstwhile firm has been acquired or taken over by the appellant Aravali Polymers LLP.”

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