Addition u/s 45 unsustainable as commercial expediency not contravened

ITO Vs Brizeal Realtors and Developers LLP (ITAT Mumbai)

ITAT Mumbai held that addition u/s 45 under the head “Capital Gains” for violation of conditions u/s. 47(xiiib) of the Act on conversion of a private limited company into the assessee LLP unsustainable as commercial expediency not contravened by AO.

Facts-The assessee is a Limited Liablity Partnership [in short, “LLP”] engaged in construction activities. The case was selected for scrutiny and statutory notices under the Income Tax Act, 1961 were issued and complied. In the assessment completed, AO made an addition of Rs. 48,35,00,000/ – u/s. 45 of the Act under the head “Capital Gains” for violation of conditions u/s. 47(xiiib) of the Act on conversion of a private limited company into the assessee LLP. Aggrieved by the said addition, the assessee preferred appeal before the ld. CIT(A) who allowed the appeal in favour of the assessee by deleting the said addition. Aggrieved by the order of the ld. CIT(A), the Revenue has preferred this appeal.

Conclusion- We find that the partners of the assessee LLP and the erstwhile shareholders of the predecessor company can be considered to have obtained any benefit directly or indirectly only if the same fits into the specific conditions prescribed. We find that the ld. CIT(A) have duly considered that the clause (c) operates only till the date of conversion i.e. 17/03/2016 and it is clear from the balance sheets pre conversion and post conversion that the shareholders have not received any consideration or benefit directly or indirectly. Further, as regards clause(f) refers to amount paid to the partner of LLPout of the balance of the accumulated profits standing in the accounts of the company on the date of conversion, which in the present case cannot be said to be violative in view of the fact that the commercial expediency explained by the assessee has not been controverted by the Assessing Officer and who cannot step into the shoes of the assessee to decide and direct as to how the assessee should conduct its state of affairs. Also, the condition prescribed relates to the balance of accumulated profits as on date of conversion out of which amount is paid to the partner, however, since the accumulated profits did not include the amount of Goodwill in the books of the predecessor company, there cannot be said to be any violation of clause (f) either. Hence, merely on presumptions of the Assessing Officer, additions cannot be sustained which the ld. CIT(A) have categorically dealt with considering all the aspects of the case.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

The present appeal is filed by the Revenue against the order dated 13/12/2019 passed by the ld. Commissioner of Income Tax (Appeals) – 45, Mumbai [in short, the Ld. CIT(A)] for A.Y. 2016-17.

2. During the course of hearing, the Revenue revised its grounds of appeal which are reproduced as under :

1. On the facts and in the circumstances of the case and in law, the Ld. CIT (A) erred in deleting the addition of Rs.48,35,00,000/ – u/s. 45 .w. 47 г.w. 170 of the Act being the Fair Market Value (FMV) of the asset worked out on account of alleged violation of the conditions of section 47(xiib) of the Act.

2. On the facts and in the circumstance of the case and in law whether the Ld. CIT(A) erred in not appreciating of the facts M/s. BRIZEAL REALTORS AND DEVELOPERS LLP has not fulfilled all the conditions prescribed u/s. 47 (xiiib) of the income Tax Act as while accounting for the Goodwill, M/s. BRIZEAL REALTORS AND DEVELOPERS LLP should have credited the amount goodwill of Rs.48,35,00,000/ – to ‘Capital Reserve’ but the assessee LLP has credited the said amount of the Partner’s current account.

3. We may note that despite notifying by Registered post as well through the Assessing Officer, neither anyone attended on behalf of the assessee nor any adjournment was filed. On other occasions also i.e. 10.2022; 26.07.2022; 12.10.2022 & 02.09.2021 ; none attended on behalf of the assessee . On many occasions, i.e. 08.09.2022, 19.05.2022, 21.06.20 22 ; 16.02.2022; 23.03.2022; 01.12.2021 & 18.01.2022 none attended, however, on written request on behalf of Ld. Counsel of the assessee, case was adjourned. In the above facts and circumstances, we are of the opinion that the assessee is not interested in responding this appeal and therefore, same was heard ex -parte qua the assessee after hearing the arguments of the ld. Departmental Representative.

4. Briefly the facts of the case are that the assessee is a Limited Liablity Partnership [in short, “LLP”] engaged in construction activities. The assessee LLP filed its return of income on 10.10.2016 declaring total income of Rs. NIL. The case was selected for scrutiny and statutory notices under the Income Tax Act, 1961 [in short, “the Act”] were issued and complied. In the assessment completed, the Assessing Officer made an addition of Rs. 48,35,00,000/ – u/s. 45 of the Act under the head “Capital Gains” for violation of conditions u/s. 47(xiiib) of the Act on conversion of a private limited company into the assessee LLP. Aggrieved by the said addition, the assessee preferred appeal before the ld. CIT(A) who allowed the appeal in favour of the assessee by deleting the said addition. Aggrieved by the order of the ld. CIT(A), the Revenue has preferred this appeal.

5. The ground no. 1 and 2 of the appeal filed by the Revenue relates to the addition of Rs. 48,35,00,000/ – on account of asset being goodwill brought into books of accounts after conversion of a Private Limited Company into LLP holding that there is a violation of provisions of section 47(xiiib) of the Act.

6. Briefly, the facts of the case qua the issue involved is that during the assessment proceedings, the Assessing Officer noticed that the company namely – M/s. Brizeal Realtors and Developers Ltd.” was converted into a LLP namely – M/s. Brizeal Realtors and Developers LLP pursuant to which a certificate was issued by Registrar of Companies [in short “ROC”] on 17/03/2016. The Assessing Officer noticed that intangible asset being “Goodwill” amounting to Rs. 48,35,00,000/ – was introduced in the books of the LLP which was not there in the block of assets of the erstwhile Private Limited Company. Accordingly, a show cause notice was issued to the assessee LLP as to why the addition of Rs. 48,35,00,000/- should not be made in its hands for violation of conditions prescribed in section 47(xiiib) of the Act. In response to the same, the assessee vide letter dated 14/12/2016 filed detailed submission with documentary evidences to substantiate that there is no violation of provisions of section 47(xiiib) of the Act. It was argued that recording of goodwill in the books of account is post conversion activity of Pvt. Ltd. Company and hence, provisions of section 45 of the Act are not applicable. The assessee LLP , was formerly a closely held company incorporated in the year 2013 for undertaking real estate activities. It was awarded a slum redevelopment project under Regulation 33(10) read with Appendix IV of the Development Control Regulations of Greater Mumbai [ in short, “the DCR 1991”] vide the Revised letter of Intent [in short, “the LOI”] dated 19/01/2015 on land bearing CTS No. 819 (part) and CTS No. 818 (part) of Shiv Shankar Nagar Co-op. Housing Society Ltd. Thereafter, the existing shareholders decided to convert the company into an LLP as per the provisions of section 56, the Third Schedule of Limited Liability Partnership Act, 2008 [in short, “the LLP Act”] and Rule 39 of the Limited Liability Partnership Rules, 2009[in short, “the LLP Rules”]. After completion of necessary procedure under the LLP Act, the company got converted into LLP and was issued a certificate of conversions dated 17/03/2016 by ROC bearing Certificate No. AAF-9714. By virtue of said conversion under the LLP Act and operation of relevant sections all the assets, interest, rights, privileges, liabilities, contractual and legal obligation and duties of the company and whole of the undertaking of the company have been vested in the LLP with effect from the date of conversion, without any further assurance, act or deed. Accordingly, all the assets and liabilities of the company immediately before the conversion were duly recorded in the books of the LLP. The contention of the assessee is that at the time of conversion of the company into LLP, there were no intangibles of any nature including Goodwill standing in the Balance Sheet of the Company and accordingly, on the date of conversion at the time of recording assets and liabilities in the books of the LLP, no Goodwill was recorded by the LLP. The only assets and liabilities that were recorded were those standing in the books of the Company. As regards the purpose of recognition of Goodwill later in the books of LLP after conversion date, the assessee explained that since the commencement of the SRA project, assessee had incurred huge rental expenses to accommodate eligible slum dwellers and enormous efforts to evacuate ineligible slum dwellers to undertake the construction activity. However, due to inability to pump in further funds and the resultant delay in the completion of the SRA project, the partners of the LLP decided to admit a new partner with adequate expertise in execution of real estate project and also infusion of necessary funds to expedite the completion of the SRA project. In contemplation of admission of new partner, the designated partners of the LLP decided to assess the value of Goodwill and therefore appointed an independent valuer. Based on the report obtained from a valuer dated 30/03/2016, the assessee recorded the Goodwill of Rs. 48,35,00,000/- in its books of accounts of LLP. Further, the contention of the assessee is that the said Goodwill is recorded only in books of LLP and not added in the block of assets for the income tax purposes. Thus, the WDV of the block of assets of the predecessor company and that of the assessee LLP continues to be the same.

6.1 However, the Assessing Officer did not accept the contentions of the assessee and concluded that the provisions of section 47(xiiib) of the Act were violated for the reasons as under: –

(i) The assessee LLP was formed on 17/03/2016 and it has been fairly admitted that the assessee had incurred huge rental expenses to accommodate eligible slum dwellers and enormous efforts to evacuate ineligible slum dwellers t o undertake the construction activity and this was admittedly done prior to 17/03/2016 by the predecessor company and not by the present assessee LLP. Thus, the Goodwill which has been now recognised in the books of the assessee LLP is by their own admission a pre-existing intangible asset, the book value of which is NIL.

(ii) The purpose of recognizing Goodwill in books of accounts of assessee LLP that it was resorted to in contemplation of admission of a new partner who would infuse funds in the SRA project is misconceived and could have been easily done by issuing shares in the predecessor company. However, that would not result into giving any benefit or paying the amounts to the shareholders of the predecessor company. The very purpose of colourable device o f conversion of an existing company to LLP, valuing and accounting of the pre-existing intangible assets in the form of Goodwill post conversion was to fraudulently pass the benefits and pay the shareholders of predecessor company without paying legitimate tax due on such ultimate

(iii) The Goodwill is valued by the valuer after considering “tremendous efforts”, procedural and implementation reasons, extensive efforts, project synopsis, extensive effort and time, huge rental expenses and enormous e, fforts time factor and so on, which clearly show that the Goodwill is nothing but a pre existing intangible asset which was valued at NIL in the books of predecessor company but valued at Rs. 48,35,00,000/ -.

(iv) The assessee LLP has recorded this Goodwill in their books of account by crediting the partner’s current account instead of crediting the same to the Capital Reserve Account. The assessee LLP has thus violated the condition (c) and (f) of section 47(xiiib).

(v) Finally, the Assessing Officer placed reliance on the decision of Celerity Power of Mumbai ITAT (ITA no. 3637/Mum/2015) and Mc. Dowell &Co. Ltd. v. CTO (1985)(3) SCC 230 (SC 5 member Bench).

7. The ld. CIT(A) however, did not find favour with the view taken by the Assessing Officer which according to him appeared to be a fig of imagination and against the law. The ld. CIT(A) held that the commercial expediency in valuing Goodwill cannot be ignored merely on the theory of presumptions.

8. The ld. Departmental Representative appearing for the revenue challenged the decision of the ld. CIT(A) and argued that the whole state of affairs of the assessee LLP have been manipulated per se merely to come out of the conditions stipulated in the provisions of section 47(xiiib) of the Act whereas if the principle of substance over form is applied and if the corporate veil is lifted, one can clearly gather that the assessee has merely adopted a colourable device to avoid tax. He vehemently relied on the findings of the Assessing Officer and requested to confirm the addition of Rs. 48,35,00,000/ – made u/s. 45 of the Act for the clear violation of the provisions of section 47(xiiib) of the Act.

9. We have heard the submission of the ld. Departmental Representative of the Revenue and perused the submissions filed before the Assessing Officer and ld. CIT(A) by the assessee. The issue involved here is whether in the present facts and circumstances of the case, the assessee LLP can be said to have violated the provisions of section 47(xiiib) of the Act or not. In the context of the present case, it is worth reproducing the relevant conditions stipulated u/s. 47(xiiib) of the Actwhich refers to transaction not to be regarded as “transfer” of a capital asset:

“47. Nothing contained in section 45 shall apply to the following transfers :—

(xiiib) any transfer of a capital asset or intangible asset by a private company or unlisted public company (hereafter in this clause referred to as the company) to a limited liability partnership or any transfer of a share or shares held in the company by a shareholder as a result of conversion of the company into a limited liability partnership in accordance with the provisions of section 56 or section 5 7 of the Limited Liability Partnership Act, 2008 (6 of 2009):

Provided that—

(a) all the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the limited liability partnership;

(b) all the shareholders of the company immediately before the conversion become the partners of the limited liability partnership and their capital contribution and profit sharing ratio in the limited liability partnership are in the same proportion as their shareholding in the company on the date of conversion;

(c) the shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the limited liability partnership;

(d) the aggregate of the profit sharing ratio of the shareholders of the company in the limited liability partnership shall not be less than fifty per cent at any time during the period of five years from the date of conversion;

(e) the total sales, turnover or gross receipts in the business of the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed sixty lakh rupees;

(ea) the total value of the assets as appearing in the books of account of the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed five crore rupees; and

(f) no amount is paid, either directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of three years from the date of conversion.

Explanation.—For the purposes of this clause, the expressions “private company” and “unlisted public company” shall have the meanings respectively assigned to them in the Limited Liability Partnership Act, 2008 (6 of 2009);

[emphasis supplied]

9.1 The relevant findings of the ld. CIT(A) is as under:-

“4.18 Only dispute is with regard to the clauses (c) and (f) above. Clause (c) lays down that the shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the limited liability partnership. It has to be taken note that in the clauses (a) to (f) of the proviso placed under section 47(xib) of the Act, the word shareholders is used in some conditions and in some conditions the word ‘partners’ is used. The usage of different words by the statute to address the same persons cannot be lost sight of. The condition (c) starts with the word ‘shareholders of the company. Shareholders of the company existed till the date of conversion of the company ie 17.03.2016 in this case. Once the certificate of registration from RoC is received for conversion to LLP, they(the shareholders) cease to be shareholders of the company and become partners of the LLP with their share of capital in the LLP. As can be seen from the Balance sheet of the erstwhile company as on 16.03.2016 and that of the LLP as on 17.03.2016, total share capital in the company was Rs. 1,61,00,000 of all the share holders, it became the share capital of Rs. 1,61,00,000 of the same persons as partners in the LLP. They (shareholders) have not received any thing more than their share capital in the LLP on the date of conversion. It is also seen that there is no time period/limit that is mentioned in clause (c). Actually, usage of the word ‘shareholders of the company’ itself restricts the time limit of operation of this condition till the date of conversion or the date of conversion, because the shareholders are shareholders of the company till the date and time the company exists. In this case the shareholders of the company are shareholders of the company till 17.03.2016. So as on the date of 17.03.2019, the shareholders received the capital in the LLP as per their shareholding in the company and nothing more. Therefore, the condition (c) operates only till the date of conversion i.e. 17.03.2016 and it is clear from the balance sheets pre conversion and post conversion that the shareholders have not received any consideration or benefit directly or indirectly. Therefore, I am of the considered opinion that there is no violation of the condition (c) of section 47 (xilib) as sought to be argued by the AO in the assessment order.

4.19 Clause (f) of the section 47(xib) lays down that no amount is paid, either directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of three vears from the date of conversion. This clause uses the terms ‘the partner of LLP’ and • accumulated profits standing in the accounts of the company on the date of conversion’. It is seen that accumulated profits are negative (Rs.1,46,535) in the company before the date of conversion. The same amount of negative balance is appearing in the LLP as on the date of conversion. It is noticed from the records that no amount was paid directly or indirectly to any partners of the LLP as on the date of conversion. It has to be noted that the condition prescribes that the such prohibition on distribution of accumulated profits extends to three years from the date of conversion. The AO in the assessment argued that the goodwill brought into the books of the LLP on 30.03.2016 was actually the accumulated profit of the company which was not mentioned in the books of the company or appearing at NIL value in the books of the company. She sought to bring in ‘capital reserve’ as part of entries the appellant is supposed to pass while bringing the goodwill into books of LLP as per her interpretation. She argued that the ‘capital reserve’ in the entries supposed to be passed is actually the accumulated profits’ of the erstwhile company. This interpretation of the AO appears to be a fig of imagination and against the very provisio she wanted to apply against the appellant. The clause (f) uses the phrase ‘out of balance of accumulated profit standing in the accounts of the company on the date of conversion’. The word ‘balance of accumulated profits’ has qualification ‘standing in the accounts of the company on the date of conversion’. Therefore, no new item, much less the presumed to be existing item can be brought into the books contradicting the phrase accumulated profits standing as on the date of conversion’. As already mentioned above, the accumulated profit (Reserves and surplus) in the company is negative as on the date of conversion. Use of the word ‘standing in the accounts of the company’ removes all the doubts about the amount to be adopted and there is no scope for introducing any amount from anywhere much less any amount which is not in the books of the company on the date of conversion. Therefore, I am of the considered opinion that there is no violation of clause (f) of section 47(xilib) of the Act as argued by the AO. Further in view of the above, the argument of the AO regarding the entries supposed to be passed by the assessee is not relevant.

4.20 AO placed reliance on McDowell & Co. Ltd Vs CTO, reported in 1985(3)SCC 230 to state that there is a colourable device in the case. In the said case the Court held that Tax planning may be legitimate if it is within the framework of law, but colourable devices cannot be part of tax planning. I am of the opinion that the conversion of the Company into LLP as per the provisions of the LLP Act, 2008 and commercial decision taken after such conversion cannot be seen as a colourable device. Further in this context. Apex Court have held that it is open for everyone to arrange its affairs in a manner so as to reduce its tax liabilities to the minimum, and such tax planning shall not be considered to be illegitimate, provided it is within the framework of law. Scheme of tax planning has been explained by the Hon’ble Supreme Court in the case of Azadi Bachao Andolan [2003] 263 ITR 706 (SC), wherein it was held that the decision in McDowell’s case cannot be read as laying down that every attempt at tax planning is illegitimate, or that every transaction or arrangement which is perfectly permissible under the law, but has the effect of reducing the tax burden of the assessee must not be looked upon with dis -favour. AO further placed reliance on the cases CIT Vs Sri Meenakshi Mills Ltd., AIR 1967 SC 819, Life Insurance Corporation of India v. Escorts Ltd. (1986) 1 SCC 264 and Juggilal Kamlapat v. CIT AIR 1969 SC 932 to argue that AO is entitled to lift the veil of the corporate entity and pay regard to the economic realities behind the legal façade. | have carefully gone through the decisions relied by the AO. This is a case where conversion of the Company into LLP has taken place as per the provisions of the LLP Act 2008. The RoC has issued the certificate for such conversion on 17.03.2016. The Income tax Act was amended in consonance with the enactment of LLP Act 2008 to provide that the subject to certain condition laid down in section 47 (xib), the capital gains are not taxable on such conversion of the Company into LLP. Assessee apparently has satisfied all the conditions. However, suggesting the entries supposed to have been passed by bringing in ‘capital reserve’ which was not there in the books of the erstwhile company, is against the principles of Interpretation of the laws. The clause (f) is very clear in specifying the words ‘out of balance of accumulated profit standing in the accounts of the company as on the date of conversion’. Interpretation of such unambiguous terms by reading in new words, giving an unintended interpretation is against the spirit of the law. This kind of reading in new words into the provision is not allowed in law and much less it can be called “lifting of corporate veil’. Reliance is placed on the decision of the Apex Court in the case of Keshavii Ravi & Co reported at 183 ITR 1 (SC), where in the Hon’ble Apex Court held that as long as there is no ambiguity in the statutory language, resort to any interpretative process to unfold the legislative intention becomes impermissible. Therefore, it is held that the case laws relied by the AO with regard to lifting of corporate veil is not relevant to the facts of the case.

4.21 Keeping in view the totality of facts and circumstances of the case as discussed in above paragraphs, I am of the considered opinion that the appellant has complied with all the conditions laid down in the proviso placed under section 47(xiib) of the Act particularly there is no violation of clauses (c) and (f) as sought to be argued by the AO. Therefore, the assessee is not liable to tax on conversion of company into LLP as per LLP Act 2008. The AO is therefore, directed to delete the addition of Rs.48,35,00,000 made in the assessment order. The appellant gets relief. These grounds are allowed.”

9.2 On going through the factual matrix of the case, the moot point for deciding here is that whether the partners of the assessee LLP had actually benefitted either directly or indirectly on conversion of the predecessor company into LLP or not which has been alleged by the Assessing Officer. It is a trite principle in law that the conditions stipulated under the Act should be strictly construed and adhered to. Further, it is also a trite principle in law that no new words can be incorporated in the statute which can give unintended interpretation against the spirit of the law. The allegation of the Assessing Officer is that the conditions in clause (c) and (f) of section 47(xiiib) of the Act being that no direct or indirect benefit should be passed on to the shareholders in any form or manner, other than by way of share of profit and capital contribution in the LLP and that no amount be paid either directly or indirectly to any of the partner out of balance of accumulated profits standing in the accounts of the company on the date of conversion for a period of 3 years ; are violated as the Goodwill of Rs. 48,35,00,000/ – has been credited to the partners current account post conversion. In this regard, we find that the partners of the assessee LLP and the erstwhile shareholders of the predecessor company can be considered to have obtained any benefit directly or indirectly only if the same fits into the specific conditions prescribed. We find that the ld. CIT(A) have duly considered that the clause (c) operates only till the date of conversion i.e. 17/03/2016 and it is clear from the balance sheets pre conversion and post conversion that the shareholders have not received any consideration or benefit directly or indirectly. Further, as regards clause(f) refers to amount paid to the partner of LLPout of the balance of the accumulated profits standing in the accounts of the company on the date of conversion, which in the present case cannot be said to be violative in view of the fact that the commercial expediency explained by the ass essee has not been controverted by the Assessing Officer and who cannot step into the shoes of the assessee to decide and direct as to how the assessee should conduct its state of affairs. Also, the condition prescribed relates to the balance of accumulated profits as on date of conversion out of which amount is paid to the partner, however, since the accumulated profits did not include the amount of Goodwill in the books of the predecessor company, there cannot be said to be any violation of clause (f) either. Hence, merely on presumptions of the Assessing Officer, additions cannot be sustained which the ld. CIT(A) have categorically dealt with considering all the aspects of the case.

9.3 Accordingly, the grounds of appeal of the revenue are dismissed.

10. In the result, the appeal of the Revenue is dismissed.

Order pronounced under Rule 34(4) of the ITAT Rules, 1963 on 30/12/2022.