PCIT Vs Atria Wind (Kadambur) Pvt. Ltd. (Karnataka High Court)
Capital Withdrawal Before Conversion Does Not Violate Section 47(xiii)—Karnataka High Court Upholds Tax-Neutral Succession of Firm By Company
Summary: The Karnataka High Court has held that capital withdrawals by partners and changes in their profit-sharing or capital-sharing ratio before the conversion of a partnership firm into a company do not, by themselves, violate the conditions prescribed under section 47(xiii). For determining compliance, the relevant comparison is between the assets and liabilities of the firm immediately before succession and those taken over by the successor company. Where all such assets and liabilities were transferred to the company and the partners received no consideration or benefit at the time of conversion other than shares in the company, the exemption under section 47(xiii) could not be denied. The Court also held that board resolutions, legal opinions, valuation reports and documents relating to the conversion, generated in the ordinary course of business, do not become “incriminating material” merely because they were found during a search.
Facts of the case
Atria Wind (Kadambur) Pvt. Ltd. was formed by succession of the partnership firm, M/s Perpetual Investments. The business consisted of operating a 50-MW wind-power project in Tamil Nadu.
The assessee filed its return for AY 2018-19 on 23 October 2018. The return was processed under section 143(1) on 17 May 2019.
A search under section 132 was conducted at the assessee’s premises on 17 December 2020. Pursuant to the search, a notice under section 153A was issued. The assessee filed a return declaring nil income, though the return was not electronically verified.
The Assessing Officer completed the assessment under sections 153A and 143(3), determining income at ₹14,99,89,081 and disallowing the deduction claimed under section 80-IA.
Revenue’s case regarding conversion
Before its conversion, Perpetual Investments had sold shares held by it in Atria Convergence Technologies to two Mauritius-based companies.
The Assessing Officer also noticed that the constitution of the firm had remained substantially unchanged until 31 December 2016. However, with effect from 1 January 2017, the partners materially altered their capital-sharing ratio. The individual partners withdrew substantial capital and reduced their share in the firm to 1%, while the share of Atria Wind Power Pvt. Ltd. increased to 94%.
Thereafter, the firm was succeeded by the assessee-company with effect from 27 March 2017.
The Assessing Officer viewed the sale of the asset, capital withdrawals, change in sharing ratio and subsequent conversion as an integrated arrangement. He concluded that the conditions under section 47(xiii), particularly provisos (a) and (c), had been violated.
On this basis, he treated the succession as a taxable transfer and denied the benefit under section 80-IA.
Findings of CIT(A) and ITAT
The CIT(A) rejected the Assessing Officer’s conclusion. The Tribunal affirmed the CIT(A)’s decision.
The Tribunal found that the succession took effect on 27 March 2017. Consequently, the assets and liabilities of the firm as existing on 26 March 2017 represented the assets and liabilities “immediately before the succession.”
The audited financial statements and other records showed that all such assets and liabilities became the assets and liabilities of the company. There was no alteration between the firm’s position immediately before succession and the company’s position immediately thereafter.
The Tribunal also found that the partners had not received any consideration or benefit upon conversion other than shares in the successor company.
High Court’s decision
The High Court upheld the Tribunal’s interpretation of section 47(xiii).
Proviso (a) requires all assets and liabilities of the firm relating to the business immediately before succession to become the assets and liabilities of the company. The statutory focus is therefore on the position immediately preceding succession and not on every transaction undertaken by the firm several months earlier.
The Court found no dispute that all assets and liabilities standing in the firm’s books on 26 March 2017 were transferred to the company on 27 March 2017.
Similarly, proviso (c) provides that the partners must not receive any consideration or benefit, directly or indirectly, in any form other than allotment of shares in the company. There was no allegation that the partners had received any such additional consideration or benefit on conversion.
The partners were allotted shares according to their interests in the firm immediately before succession. The Court held that there was no statutory embargo against partners withdrawing funds from the firm before succession. Transactions completed before succession did not render the subsequent conversion taxable under provisos (a) and (c).
No incriminating material found during search
The CIT(A) and Tribunal had also found that no incriminating material was discovered during the search.
The Department relied on board resolutions, no-objection certificates, a solicitor’s note regarding sale of shares and depreciation, valuation reports and documents concerning the firm’s constitution.
The High Court held that these were ordinary documents relating to the firm’s business and its conversion into a company. Such documents could not be regarded as incriminating merely because they were seized during the search.
Following PCIT v. Abhisar Buildwell Pvt. Ltd., the Tribunal had held that the section 153A proceedings concerning the completed assessment were not sustainable in the absence of incriminating material. The High Court found no error in this conclusion.
Accordingly, no substantial question of law arose and the Revenue’s appeal was dismissed.
Author’s comments
The ruling adopts a literal and commercially workable interpretation of the words “immediately before the succession.” Section 47(xiii) does not require that the firm’s assets, capital accounts or profit-sharing ratio must remain frozen for any prescribed period before conversion.
Therefore, an asset sold by the firm before succession is no longer an asset required to vest in the successor company. Similarly, amounts lawfully withdrawn by partners before succession do not automatically become consideration received by them for the conversion.
However, the decision should not be treated as giving unrestricted approval to pre-conversion capital stripping. The finding was based on the absence of evidence showing that the partners received any consideration or benefit, directly or indirectly, as part of the succession arrangement. If the Revenue establishes that the withdrawal and conversion formed part of a sham, prearranged or colourable transaction intended to distribute consideration for the transfer, the result could be different.
The decision is also confined to section 47(xiii). Capital withdrawals, reconstitution of a firm or distribution of assets may independently attract other provisions, particularly under the law applicable to the relevant assessment year. The tax consequences of the earlier sale of assets and withdrawals must therefore be examined separately.
On the search issue, the ruling reiterates that a document does not become incriminating merely because it is found during a search. Routine corporate documents must reveal undisclosed income or contradict the assessee’s earlier disclosures before they can support additions in a completed assessment under section 153A.
The judgment thus rests on two independent grounds: the conversion satisfied section 47(xiii) on merits, and the completed assessment could not, in any event, be disturbed under section 153A without incriminating material.
Cases Discussed
FULL TEXT OF THE JUDGMENT/ORDER OF KARNATAKA HIGH COURT
1. For the reasons stated in the application-I.A.No.1/2026, the same is allowed. The delay of 31 days in filing the appeal is condoned.
2. The department [the appellant] has filed the appeal under Section 260A of the Income Tax Act, 1961 [the Act] impugning the order dated 08.10.2025 passed by the Income Tax Appellate Tribunal, Bengaluru [the ITAT] in I.T.A.No.1023/Bang/2025 for the Assessment Year [AY] 2018-19. The department had filed the said appeal impugning the order dated 19.02.2025 passed by the Commissioner of Income Tax (Appeals)-15, Bengaluru [the CIT(A)] in CIT(A) No.11/BNG/10755/2017-18. The respondent [the Assessee] had filed the said appeal impugning the Assessment Order dated 30.03.2022 passed by the Assessing Officer [the AO] under Section 143(3) read with Section 153A of the Act.
3. In the given facts, the department has projected the following substantial questions of law:
“1. Whether under the facts and circumstances of the case and in law, the Tribunal was right in holding that documents such as Board Resolutions, legal notes, and valuation reports seized u/s 132 do not constitute “incriminating material” when such evidence was neither disclosed during regular assessment nor available on record prior to the search?
2. Whether under the facts and circumstances of the case and in law, the Tribunal was right in interpreting Section 47(xiii) by failing to appreciate the modus operandi adopted by the assessee and the direct nexus between the earning of capital, the withdrawal of capital by partners through an unregistered deed, and the subsequent conversion?
3. Whether under the facts and circumstances of the case and in law, the Tribunal is right in ignoring the sequence of events which clearly established a violation of the conditions prescribed under the proviso to Section 47(xiii) and as such the findings of the Tribunal perverse?”
4. The Assessee, M/s Atria Wind (Kadambur) Pvt. Ltd., was formed by succession from the firm, M/s Perpetual Investments [the Firm] and is engaged in the business of generation and sale of electrical power. The Assessee owns a wind power project having a capacity of 50 megawatt capacity in the State of Tamilnadu.
5. The Assessee filed its return of income under Section 139 of the Act on 23.10.2018 for the AY 2018-2019. The same was processed under Section 143(1) of the Act on 17.05.2019. Subsequently, a search under Section 132 of the Act was conducted at the office premises of the Assessee on 17.12.2020. Pursuant to the said search, the AO issued notice under Section 153A of the Act on 28.09.2021, calling upon the Assessee to file its return of income. The Assessee filed its return on 29.10.2021, declaring nil income. However, the Assessee did not e-verify the return of income. The AO, by order dated 30.03.2022 passed under Section 153A read with Section 143(3) of the Act, assessed the total income at ₹14,99,89,081/-.
6. In the said proceedings, the AO disallowed the deduction claimed under Section 80-IA of the Act. The AO found that the Firm had been converted into a company by way succession. However, prior to the succession, M/s Perpetual Investments had sold one of its assets [shares held in Atria Convergence Technologies (ACT)] on 06.05.2016 for a total consideration of ₹394,94,99,14,233/- to two Mauritius based companies, namely, M/s Argan (Mauritius) Limited and M/s TA FVCI Investors Limited.
7. The AO also found that the constitution of the Firm remained the same for most of the assessment years till the date of 31.12.2016. However, the capital sharing ratio was materially changed on 01.01.2017. The individual partners withdrew their capital and reduced their share in the Firm to 1%. The share of one of the constituent partners, Atria Wind Power Private Limited increased to 94%.
8. The AO was of the view that the proviso (c) to Section 47(xiii) of the Act was attracted, therefore, the conversion of the Firm to the Assessee would constitute a transfer within the meaning of Section 45 of the Act. On the basis of the said reasoning, the AO proceeded to hold the benefit of Section 80-IA of the Act would not be available to be Assessee.
9. The Assessee preferred an appeal against said order before the learned CIT(A). On merits, the learned CIT(A) rejected the AO’s finding that Section 47(xiii) of the Act was inapplicable. The department appealed the CIT(A)’s decision to the learned ITAT. The learned ITAT upheld the CIT(A)’s view observing as under:
“5.5 Next, we will consider the issue on merits, whether the assessee had committed any violation of the provisos to Section 47 (xiii) of the Act as alleged by the AO. We will go through the reasons stated by the AO for levying long term capital gains tax on the transfer of the firm’s capital asset to the assessee as a result of succession of the firm by the company in the business carried on by the firm, when the assessee had not violated any of the conditions mentioned in the provisos to section 47(xiii) of the Act. The AO initially issued a show cause notice, proposing to add the long-term capital gains for the reason that the assessee had violated section 47(xiii) proviso (a) & (c) of the Act. Subsequently the assessee filed their detailed objections and demonstrated before the AO that none of the provisos were violated by them while transferring the firm into a company and therefore, claimed that the addition made under the head long term capital gains is not warranted. For the purpose of clarity, we are reproducing the objections filed by the assessee which is as follows:..
….5.6 We have gone through the above detailed reply filed by the assessee and from that we are able to see that the succession was taken into effect from 27.03.2017 and all the assets and liabilities of the firm relating to the business of the firm immediately before the succession i.e on 26.03.2017 becomes the assets and liabilities of the assessee company. The assessee had enclosed the copy of the audited financial statements of the firm for the period up to 26.03.2017 at page numbers 71 to 85 in support of their contention. Similarly, the assessee also filed the summary of assets and liabilities of the firm as on 26.03.2017 in page 86 of the paper book. Even though the assessee filed number of documents, we are relying on the following documents in order to appreciate the facts.
a) Copy of the ITR V and IT Return of the firm for the assessment year 2016-17.
b) Copy of the Partnership Deed dated 31.01.2008 and the Indenture of Reconstitution of partnership at 10.04.2015 and the copy of the Reconstitution of partnership dated 16.01.2017.
c) Copy of the stamped affidavit for dissolution of firm.
5.7 In order to appreciate the explanation offered by the assessee, we have gone through the proviso (a) to section 47(xiii) of the Act in which the words used are that “immediately before the succession”, which means that the assets and liabilities of the firm immediately before the date of succession would become the assets and liabilities of the company. In this case, the succession was taken into effect from 27.03.2017 and therefore all the assets and liabilities of the firm stood immediately before the date of succession i.e as on 26.03.2017 vests with the company. The meaning of the word immediately as given in the Black’s Law Dictionary is as follows;
“without interval of time, without delay, straight away”.
10. It is apparent from the above that the learned ITAT has recorded a finding of fact to the effect that the assets and liability of the Firm as on 26.03.2017, immediately before its succession by the Assessee, became the assets and liabilities of the Assessee. It is not disputed that there was no change in the assets and liabilities of the firm immediately prior to the succession and those of the company post-succession.
11. It is relevant to refer to proviso (a) and (c) to Section 47(xiii) of the Act, which are reproduced below:
“47. Nothing contained in section 45 shall apply to the following transfers:
[(xiii) any transfer of a capital asset or intangible asset by a firm to a company as a result of succession of the firm by a company in the business carried on by the firm, or any transfer of a capital asset to a company in the course of [demutualisation or] corporatisation of a recognised stock exchange in India as a result of which an association of persons or body of individuals is succeeded by such company:]
Provided that-
(a) all the assets and liabilities of the firm [or of the association of persons or body of individuals] relating to the business immediately before the succession become the assets and liabilities of the company;
(b) xxx;
(c) the partners of the firm do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of allotment of shares in the company; and”
12. There is no allegation that the constituent partners of the Firm had received any consideration or benefit, directly or indirectly, in any form or manner other than by way of allotment of shares on the conversion to the Assesee company. It is not disputed that the partners were allotted shares in lieu of their shares in the Firm as held by them immediately preceding the succession. There was no embargo or restriction on the partners withdrawing any fund from the firm prior to its succession and any transaction done prior to succession does not render the succession as a transfer within the meaning of proviso (a) and (c) of Section 47(xiii) of the Act.
13. The learned ITAT’s finding of fact that the assets and liabilities of the Firm as on 26.03.2017, immediately prior to its succession, were transferred to Assessee cannot be assailed as perverse.
14. The CIT(A) also found that no incriminating material had been found during the search. We note that documents such as the Board Resolution, NOCs issued by M/s Perpetual Investments for conversion of the firm into a company, a note prepared by the solicitors regarding sale of equity shares and depreciation, the valuation report prepared in respect of fixed and documents relating to the legal constitution of the Firm prior to its succession to the Assessee, could not be considered as incriminating documents.
15. The learned ITAT also found that there were no incriminating materials found during the search. Following the decision of the Supreme Court in Principal Commissioner of Income Tax V. Abhisar Buildwell Pvt. Ltd.1, the proceedings under Section 153A of the Act were held to be not maintainable.
16. A plain reading of the documents indicates that there is no dispute that the Firm was succeeded by the Assessee. The valuation reports, legal notes and Board Resolutions are all documents relating to and arising in the natural course of the Assessee’s activities. Insofar as the question whether the succession into a company was within the scope of Section 47(xiii) of the Act is concerned, the same is premised on a factual finding that there was no alteration of the assets and liabilities of the Firm on account of the Assessee succeeding to the said assets and liabilities. The fact that, prior to such succession, the Firm had sold certain assets and the shares of the partners were changed does not affect the applicability of provisions of Section 47(xiii) of the Act.
17. No substantial question of law arises in this appeal.
18. The appeal is accordingly dismissed.
Notes:
1 2023 SCC OnLine SC 481
