Case Law Details
ITO Vs NICAF LLP (TAT Mumbai)
Mumbai ITAT dismisses Section 68 addition on NICAF LLP, clarifying that Section 47(xiiib)(f) violations relate to capital gains, not unexplained credits, in company-to-LLP conversions.
In a significant ruling clarifying the application of income tax provisions concerning company-to-Limited Liability Partnership (LLP) conversions, the Income Tax Appellate Tribunal (ITAT), Mumbai Bench, has dismissed an appeal filed by the Income Tax Officer (ITO) against NICAF LLP. The Tribunal upheld the decision of the Commissioner of Income Tax (Appeals) [CIT(A)], National Faceless Appeal Centre (NFAC), which had deleted a substantial addition of Rs. 2,71,66,500/- made by the Assessing Officer (AO) under Section 68 of the Income Tax Act, 1961. The core of the dispute revolved around the interpretation of Section 47(xiiib)(f) and its interplay with Section 68 of the Act.
Background of the Case
NICAF LLP, engaged in the business of trading and installation of carpets and floor coverings, was originally NICAF Private Limited. The company underwent a conversion into an LLP effective December 2, 2016. For the Assessment Year 2017-18, the assessee had filed its return of income declaring a total income of Rs. (-38,274). The case was subsequently selected for limited scrutiny under the Computer Assisted Scrutiny Selection (CASS) system.
During the assessment proceedings, the AO observed that prior to the conversion, NICAF Private Limited’s balance sheet reflected a share capital of Rs. 11,95,410/- and reserves & surplus amounting to Rs. 2,71,66,498/-. Post-conversion, these amounts were credited to the capital accounts of the partners in NICAF LLP. The AO took the view that this action violated the conditions stipulated under Section 47(xiiib)(f) of the Act. Specifically, the AO contended that this provision prohibits any direct or indirect payment to partners out of accumulated profits for a period of three years from the date of conversion. The AO interpreted the crediting of reserves and surplus to partners’ capital accounts as a violation intended to evade Dividend Distribution Tax (DDT) that would otherwise be leviable on profit distribution as dividends. Consequently, the AO treated the entire amount of Rs. 2,71,66,498/- as an unexplained credit under Section 68 read with Section 115BBE of the Act, adding it to the assessee’s total income. The total income was thus determined at Rs. 2,71,66,500/-.
First Appellate Stage: CIT(A)’s Decision
Aggrieved by the AO’s order, NICAF LLP appealed to the CIT(A). The first appellate authority, after examining the documentary evidence, concluded that there had been no direct or indirect payment made to the partners’ accounts from the LLP towards accumulated profits for a period of three years. The CIT(A) held that Section 47(xiiib)(f) was not attracted in this scenario, as the transfer of capital assets from the private limited company to the LLP was tax-neutral, adhering to the specified conditions in the proviso to Section 47(xiiib). Accordingly, the CIT(A) deleted the addition made by the AO.
Revenue’s Appeal to ITAT and Assessee’s Cross-Objection
The revenue, dissatisfied with the CIT(A)’s decision, filed an appeal before the ITAT, challenging the deletion of the addition. The learned Departmental Representative (DR) reiterated the AO’s stance, arguing that crediting the entire reserves and surplus to the partners’ capital accounts violated Section 47(xiiib)(f) and was an attempt to evade DDT. The DR cited the co-ordinate bench decision in ACIT vs. Celerity Power LLP [2019] 174 ITD 433 (Mum. Trib.) in support of the revenue’s position, urging the ITAT to uphold the Section 68 addition.
Conversely, the learned Authorized Representative (AR) for NICAF LLP countered these arguments. The AR emphasized that no amount was paid, directly or indirectly, to the partners from the accumulated profits of the company for the stipulated three-year period, a fact corroborated by the partners’ bank statements. The AR further contended that the AO had wrongly invoked Section 68, as there was no “unexplained credit” in the assessee firm’s accounts. The AR argued that even if a transfer was deemed to have occurred, any tax implication should arise in the hands of the partners, not the assessee firm. The assessee’s AR relied on the favourable order of the CIT(A).
ITAT’s Analysis and Ruling
The ITAT meticulously examined the rival submissions and the relevant provisions of the Income Tax Act. The core issue before the Tribunal was whether the addition made under Section 68 was justified.
The Tribunal first delved into the interpretation of Section 47(xiiib) of the Act. This section outlines specific transactions that are not regarded as transfers for the purpose of computing capital gains under Section 45. It provides for tax neutrality when a private or unlisted public company converts into an LLP, provided certain conditions are met. Condition (f) of the proviso to Section 47(xiiib) specifically states 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 years from the date of conversion.” The legislative intent behind this condition is to prevent the distribution of accumulated profits in a tax-free manner through the conversion route, which would otherwise be subject to Dividend Distribution Tax (DDT) if distributed as dividends by the company. If any of these conditions are violated, the conversion loses its tax-neutral status, and the capital gains arising from the transfer of assets and liabilities from the company to the LLP become taxable in the hands of the transferor company or its shareholders, as the case may be, under Section 45.
The ITAT then critically distinguished the application of Section 47 from Section 68. Section 68 deals with “cash credits” found in the books of an assessee for which the assessee offers no satisfactory explanation regarding their nature and source. If the assessee fails to explain the nature and source of such credits to the satisfaction of the AO, the amount credited may be charged to income tax as the income of the assessee.
Applying this distinction to the facts of the case, the ITAT observed that the share capital and reserves & surplus of the erstwhile company were simply reflected as partners’ capital in the LLP post-conversion. The Tribunal emphasized that the “nature and source” of these credits were not unexplained; they originated from the converting company’s balance sheet. Therefore, the fundamental ingredient for invoking Section 68—the existence of an unexplained credit—was absent.
The ITAT further clarified that even assuming, for argument’s sake, that there was a violation of Section 47(xiiib)(f), the consequence of such a violation would be the loss of tax neutrality for the conversion. This would lead to the computation of capital gains under Section 45, which would be taxable in the hands of the transferor company or its shareholders, not as an unexplained credit under Section 68 in the hands of the transferee LLP. The AO had erred in making the addition in the hands of the LLP under Section 68 when the alleged “credit” was not unexplained and, in any event, the taxability, if any, would lie with the transferor.
Regarding the judicial precedent cited by the DR, ACIT vs. Celerity Power LLP, the ITAT did not explicitly discuss or distinguish it in its final reasoning. The Tribunal’s decision was based on a direct interpretation of the statutory provisions and the fundamental principles governing Sections 47 and 68, highlighting their distinct scopes and applications. The ITAT’s ruling implicitly suggests that the Celerity Power LLP case, if it indeed supported the revenue’s contention for a Section 68 addition in similar circumstances, was not found persuasive in the context of the specific facts and legal interpretation adopted by this bench.
In conclusion, the ITAT found no infirmity in the CIT(A)’s order deleting the addition. The Tribunal categorically stated that none of the ingredients of Section 68 were attracted in the present case. Since the issue of capital gains taxability in the hands of the transferor was not before them, the ITAT refrained from commenting on that aspect.
Accordingly, the ITAT dismissed the revenue’s appeal and allowed the assessee’s cross-objection, providing a significant clarification on the tax treatment of company-to-LLP conversions and the limitations of invoking Section 68 for alleged violations of Section 47(xiiib)(f).
FULL TEXT OF THE ORDER OF ITAT MUMBAI
This appeal has been filed by the revenue and cross objection filed by the assessee, challenging the order of the learned Commissioner of Income Tax (Appeals) Delhi (‘ld. CIT(A)’ for short), National Faceless Appeal Centre (‘NFAC’ for short) passed u/s.250 of the Income Tax Act, 1961 (‘the Act’), pertaining to the Assessment Year (‘A.Y.’ for short) 2017-18.
2. The solitary ground of appeal raised by the revenue challenges the order of ld. CIT(A) on deletion of addition of Rs. 2,71,66,500/- made by the learned Assessing Officer (‘ld. A.O.’ for short) u/s. 68 r.w.s. 115BBE of the Act as unexplained credit as being without considering the provisions of Section 47(xiiib)(f) of the Act.
3. Brief facts of the case are that the assessee firm is engaged in the business of trading and installation of carpets and floor coverings dealing in variety of tufted carpets, rugs, wooden floorings. The assessee also undertakes installation, reinstallation and cleaning of carpets and floorings. The assessee had filed its return of income dated 29.09.2017 declaring total income at Rs. (-38,274) and the same was processed u/s. 143(1) of the Act. The assessee’s case was selected under CASS for limited scrutiny and notices u/s. 143(2) and 142(1) of the Act were duly issued and served upon the assessee. The ld. AO observed that NICAF Private Limited is converted to NICALF LLP w.e.f. 2.12.2016, where in the balance sheet of NICALF, it was observed that the assessee company had Rs.11,95,410/- as share capital and Rs.2,71,66,498/- as Reserves & Surplus before conversion. Further, it was observed that the assessee has taken both the balance as capital of the partners of M/s. NICAF LLP as per the financials of the company post conversion to LLP. The ld. AO held that as the assessee has violated the conditions of Section 47(xiiib)(f) of the Act, where it cannot take any amount directly or indirectly to any partner, out of accumulated profit for a period of 3 years from the date of conversion. The ld. AO treated the same as unexplained credit in the hands of the assessee and made an addition of Rs. 2,71,66,498/- to the total income of the assessee u/s. 68 r.w.s. 115BBE of the Act, thereby determining total income at Rs. 2,71,66,500/-, vide assessment order dated 30.12.2019, u/s. 143(3) of the Act.
4. Aggrieved the assessee was in appeal before the first appellate authority, who vide order dated 18.12.2024, deleted the impugned addition on the ground that on perusal of the documentary evidences, it is observed that there has been no direct or indirect payment made to the partners’ account from the LLP towards the accumulated profit for a period of 3 years and therefore held that Section 47(xiiib)(f) of the Act is not attracted as the transfer of the capital asset by private limited company to LLP has been tax neutral and as per the conditions specified in proviso (a) to (f) of the Section 47(xiiib)(f) of the Act.
5. The revenue is in appeal before us, challenging the impugned order of the ld. CIT(A).
6. The learned Departmental Representative (‘ld. DR’ for short) for the revenue contended that the assessee has credited the entire reserves and surplus to the capital accounts of the partners in the LLP which violates the conditions prescribed u/s. 47(xiiib)(f) of the Act. Further, the ld. DR contended that the said provisions prohibit any payment to the partners’ account towards accumulated profit for 3 years from the date of conversion and that the same was to evade Dividend Distribution Tax (DDT) which was liable to be paid by the assessee on profit distribution as dividend. The ld. DR relied on the decision of the coordinate bench in the case of ACIT vs. Celerity Power LLP [2019] 174 ITD 433) (Mum. Trib.). The ld. DR further relied on the order of the ld. AO and prayed that the addition u/s. 68 r.w.s. 115BBE be upheld.
7. The learned Authorised Representative (‘ld. AR’ for short) for the assessee on the other hand controverted the said fact and contended that the assessee has not paid any amount to its partners directly or indirectly from REC bonds out of the accumulated profits as per the financials of the company as on date of conversion for a period of 3 years. The ld. AR further stated that the same is corroborated from the bank statement of the partners. The ld. AR iterated that Section 68 was wrongly invoked by ld. AO, where there has been no unexplained credit found in the account of the assessee firm and even otherwise, assuming that there was transfer the same has to be taxed in the hands of the partners and not the assessee firm. The ld. AR relied on the order of ld. CIT(A).
8. We have heard the rival submissions and perused the materials available on record. The moot issue that requires adjudication is whether the addition made u/s. 68 r.w.s. 115BBE by the ld. AO has to be upheld or whether the ld. CIT(A) was right in deleting the impugned addition. It is observed that in the balance sheet of NICALF, the share capital and the reserves and surplus was Rs.11,95,410/- and Rs.2,71,66,498/-, respectively, as on date of conversion and post conversion, the same was owned up in the hands of the partners which according to the ld. AO was utilization of accumulated profits reflecting in the accounts of the company which were not distributed to the shareholders for evading payment of dividend distribution tax by directly crediting the same to the capital account of the partners. The revenue contends that it is in violation of the provisions of Section 47(xiiib)(f) of the Act, for which it is trite to reproduce the provision\ as herein under:
47. Transactions not regarded as transfer.
(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 57 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.
9. On a bare perusal of the said provision, it is evident that Section 47 provides for a certain situation which does not amount to transfer for the purpose of determining the capital gain as per Section 45 of the Act. Further, clause (xiiib) states that when there is a transfer of capital or intangible asset by a private company or unlisted public company to a limited liability partnership or were there is a transfer of shares held in the company by a shareholder, as a result of conversion of the company into limited liability partnership as per Section 56 or 57 or Limited Liability Partnership Act, 2008, then the same again would not amount to a transfer as per Section 45 of the Act, provided the conditions specified in sub clause (a) to (f) are not violated by the assessee. The said clause (f) specifically states that there can be no payment directly or indirectly to any partner out of the accumulated profit standing in the accounts of the company as on the date of conversion which is prohibited for a period of 3 years from the date of conversion.
10. From the above, it is evident that Section 47 pertain only to transfer for the purpose of Section 45 which is for determining the capital gain on profits or gains arising from such transfer of a capital asset. In the present case in hand, though the ld. AO has specifically mentioned that the assessee has violated the conditions u/s. 47(xiiib)(f) of the Act, he has proceeded to make addition u/s. 68 of the Act, which is specifically for credits in the books of the assessee for which the assessee offers no explanation as to the nature and source to the satisfaction of the ld. AO.
11. In the present case in hand, it is not the issue of credits found in the assessee’s books of accounts rather it is the allegation that the assessee firm upon conversion to LLP has transferred the share capital and reserves and surplus to the partners’ accounts, which is quite evident that the nature and source of the credit is not unexplained. Further, the ld. AO has also erred in making addition in the hands of the assessee, when even assuming that there was transfer, it is the credit in the partners’ account and not in the assessee’s account. We are not justified in upholding the addition made by the ld. AO u/s. 68 of the Act, were none of the ingredients of the said provision is attracted in present case in hand. The violation of condition prescribed u/s. 47(xiiib)(f) of the Act is only with regard to the computation of capital gain u/s. 45 on certain transfers of a capital asset. The ld. AO has failed to give a finding on the issue of whether the alleged transfer would be liable for capital gain and that to the same has to be in the hands of the transferor. As this issue is not before us and it is also not the case of neither the revenue nor the assessee, we are refraining from giving our view on the same. The limited scope of the present appeal is pertaining to Section 68 addition which we have given a categorical finding that the same is not attracted in the present case in hand on the abovementioned observation. We therefore find no infirmity in the order of ld. CIT(A) in deleting the impugned addition and hence, dismiss the grounds of appeal raised by the revenue. As we have upheld the order of ld. CIT(A), the grounds raised by the assessee in the cross objection is hereby allowed.
12. In the result, the appeal filed by the revenue is dismissed and the cross objection filed by the assessee is allowed.
Order pronounced in the open court on 18.06.2025
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