Case Law Details

Case Name : In re M/s Umicore Finance Luxembourg (A.A.R. No. 797 of 2009)
Appeal Number :
Date of Judgement/Order :
Related Assessment Year :
Courts : AAR Delhi (26) Advance Rulings (1661)

This Tax Alert summarises a recent ruling of the Authority for Advance Rulings (AAR) [A.A.R. No. 797 of 2009] in the case of M/s Umicore Finance Luxembourg (Applicant). There was a sale of shares of a company by its shareholders which had received such shares on conversion of a firm into the company, under the provisions of Part IX of the Indian Company Law (ICL).

The issue was whether such sale of shares, in violation of a condition of lock-in period provided in the Indian Tax law (ITL), resulted in the withdrawal of the exemption of capital gains under the ITL. The AAR held that no capital gains arose in the event of conversion of firm into company and, hence, on a subsequent noncompliance of a condition under the ITL, there can be no liability to pay tax on capital gains which did not arise in the first place.

Background

Part IX of the ICL provides for a process under which a firm is conferred with the status of a company by the process of law. Upon registration as a company, all assets and liabilities of the firm would vest in the company (Part IX conversion).

The Bombay High Court (HC) in the case of CIT Vs. Texspin Engg. & Mfg Works [263 ITR 345] (Texspin case) has taken a view that Part IX conversion does not involve transfer from one entity to another and the process merely involves statutory vesting of assets into the fold of the company. Further, the HC held that the firm does not receive any consideration from the company. In the absence of both transfer and receipt of consideration by the firm, the HC held that there is no capital gains tax liability on the firm upon Part IX conversion.

From tax year 1998-99, the ITL provides for exemption from capital gains to a firm as a result of transfer of the business to a company, if certain conditions are fulfilled. One such exemption condition is that the aggregate of the shareholding in the company of the partners of the firm is not less than 50% of the total voting power in the company and their shareholding continues to be as such for a period of five years from the date of the conversion (Lock-in Exemption Condition). Violation of any of the conditions results in withdrawal of the exemption, resulting in payment of tax by the company in the year of such violation.

The Texspin case was prior to introduction of the above exemption provision in the ITL.

Facts of the case

The Applicant is a company, incorporated and having its registered office in Luxembourg. It acquired virtually all the shares of a company in India (Ind Co) from its shareholders in 2008.

Indian Co was incorporated as a private limited company in 2005, on conversion of a firm pursuant to Part IX conversion.

Pursuant to the incorporation of Ind Co under Part IX conversion, all the assets and liabilities of the firm vested in Ind Co at book value and the partners of the firm became the shareholders of Ind Co, having share holdings identical with the profit sharing ratio in the firm.

The acquisition of shares of Ind Co by the Applicant in 2008 resulted in the shareholding of the partners of the erstwhile firm being reduced to less than 50% of the total voting power before five years from the date of conversion (2005). This was perceived as violative of the Lock-in Exemption Condition of the ITL.

Issues before the AAR

Whether the Part IX conversion of the firm in 2005 will be regarded as transfer under the provisions of the ITL.

Whether violation of the Lock-in Exemption Condition on sale of shares of Ind Co to the Applicant in 2008 will result in forfeiture of capital gains exemption in the hands of Ind Co under the ITL.

Contentions of the Applicant

The Applicant was of the view that the Part IX conversion of the firm and the consequent vesting of assets in Ind Co did not amount to transfer and no capital gains had arisen to the firm within the provisions of the ITL.

The presence of a specific exemption provision in the ITL does not mean that Part IX conversion otherwise results in a transfer, thereby triggering a tax liability.

Therefore, the liability to pay capital gains cannot be fastened on Ind Co even in case of non-compliance of the Lock-in Exemption Condition of the ITL, as there was no capital gains tax liability on the firm at the threshold itself.

Ruling of the AAR

The Applicant’s case is akin to the Texspin case. The reasoning in the Texspin case that there is no transfer of capital asset in Part IX conversion and consequently no capital gains liability, should apply with equal force to the case of the Applicant.

Introduction of a specific exemption provision in the ITL cannot be construed to mean that income which is not liable to be taxed under the ITL can be taxed if there is non-compliance of the exemption provision.

If no profit or gain arose on Part IX conversion of firm into company or if there was no transfer at all of capital assets of the firm upon conversion, the ITL provisions resulting in the withdrawal of exemption cannot be invoked to levy tax on the company.

Assuming that there was transfer of capital asset of the firm in favor of Ind Co, such a transfer did not result in any profit or gain to the partners of the firm. The value of shares of Ind Co allotted to the partners of the firm is nothing more than the value of the sum total of their proprietary interest in the firm. The partners have not become richer to any extent.

In a Part IX conversion, all the assets automatically vest in the newly registered company, as per the statutory mandate. Hence, it cannot be said that the partners have made any gain or received any profit.

Relying on the Tex spin case, the very asset transferred or parted with cannot be the consideration for transfer and, therefore, the market value of that asset cannot enter into computation of capital gains. ‘Full value of consideration’ cannot, therefore, be attributed to the transaction. Further, computation of capital gains is an integral part of the charging provision under the ITL as held in the case of B.C. Srinivasa Shetty’s case [128 ITR 294] (Supreme Court).

No capital gains accrued or arose at the time of Part IX conversion of the firm into Ind Co and, therefore, by reason of premature transfer of shares, Ind Co is not liable to pay capital gains tax.

Comments

This ruling provides guidance by reaffirming the principles laid down by the Bombay HC in the Texspin case to the effect that Part IX conversion does not result in a taxable event.

It is pertinent to note that the Finance Bill, 2010 proposes to introduce specific exemption provisions for protecting conversion of a company into a limited liability partnership, on fulfillment of certain conditions.

A ruling by the AAR is binding only on the Applicant, in respect of transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the Applicant and the said transaction. However, it does have persuasive value and the Courts in India, the Tax Authority and the appellate authorities do recognize the principles and ratios laid down by the AAR, while deciding similar cases.

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0 Comments

  1. Suresh Gala says:

    Is there any Lock in period to hold the shares allotted to the partners at the time of conversion of Firm into a Company?

    Pls.throw some light on tax implication if such shares sold after conversion say after 2 years.

    Suresh M. Gala

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