The matter for discussion attempted herein, – based on independent thoughts and own viewpoints shared hereby, – concerns the ongoing controversy, with presumably no specific direction or clues for guidance in mind; which is as regards the tax implications of section 47(xiiib), rtw sec 47 A(4) (for short, the enactment), of the Income Tax Act (for short, IT Act).
The enactment prima facie deserves to be commended as a specimen for impulsive and mindless legislation of all in recent times. Be that as it may, in substance, what is provided is that the event of Conversion of a Company to a LLP (short for- Limited Liability Partnership), in the year of such conversion, shall not be subject to capital gains; provided certain conditions as prescribed are, and continue to be fulfilled ,or remain fulfilled for a period respectively specified, as mandated.
The consequence of non-fulfilment of so specified conditions, leads to withdrawal of tax exemption by virtue of the deeming provision as embodied in sec 47 A (4). On such withdrawal, the tax chargeable, for the year of conversion, – which but for the exemption, would have been to the account of and borne by the predecessor-company,- is mandated to be borne by the ‘successor- LLP or ‘the shareholders of the predecessor –company’.
The enactment, though looks simple enough /innocuous, has every prospect of giving rise to a horrendous exercise for seamless compliance; more so, in implementation and enforcement, with success. To be precise, the entire scheme of these provisions has inherent complicity; and, is potent with inevitably prolonged but inconclusive disputes and litigation.
2. In his eminent speech on the nuances of the then Finance Bill, 2016 (with a related amendment as then proposed, since enacted and is in force), a reputed Tax counsel has, with reference to the provisions section 47(xiiib), opined that,-
the law is well settled by the judgement of the Bombay High Court in CIT vs. Texspin Engineering and Manufacturing Works (2003) 263 ITR 345 (Bom) that such conversions (under Part IX of the Companies Act) are a mere change of the “legal avatar” and do not result in a “transfer” which can attract capital gains. However, by conferring an exemption and making it subject to fulfilment of conditions, the implication is that the non-fulfilment of the conditions will result in a tax liability even though there is none on FIRST PRINCIPLES.
(Source: “Important Nuances Of The Finance Bill 2016” -(Address at the function organised by BCAS – Report @ itatonline.org.)
For related expert commentary, with cited case law to support, may look up Pakhivala’s Text Book (Tenth Edition, Volume I, Pg. 1212 (for short, the Text Book)
2. The full text of the Bom. H.C. Judgement in the referred Texspin’s case has been reported and is available, also @ https://indiankanoon.org/doc/1365681/
In that case, as noted from the text of the Judgment, a partnership firm (registered under the Indian Partnership Act, 1932) was carrying on the business of manufacture of ball bearings. The firm was later converted into a limited liability company, as provided for in Part IX of the Companies Act, 1956.
The court has, in settling the tax issue in assessee’s favour, held to the effect that such conversion of a firm into a company was a mere change of one form of legal entity to another, and did not result in a ‘transfer’ within its legal connotation, so as to attract tax on ‘capital gains’.
2.1. Contrary to, and belying, the positive expectations in limited legal circles, however, that was not to be the final and binding ruling. For, in ACIT v. M/ s Celerity Power LLP (ITA No. 3637/ Mum/ 2015), the Bom. Bench of ITAT, taking a view in favour of the Revenue, has since opined to the effect that the above cited Bom. HC Judgment, so also another Judgment of the Guj.HC cited, mainly relied upon by the assessee, are distinguishable; hence not followed.
The Tribunal has taken the contrary view, in favour of the Revenue, on inter alia the grounds below:
But for a specific exemption under section 47, the law seeks to treat the conversion as transfer taxable under section 45 of the Act. Further, in the Memorandum to the Finance Bill, 2010, in which section 47(xiiib) of the Act was introduced, it has been explained that such conversion involves a transfer of assets and can lead to tax implications. In addition, the term ‘convert’ used in relation to a private limited company changed into a LLP includes a ‘transfer of the property’as envisaged in the Limited Liability Partnership Act, 2008. Accordingly, the conversion of a company into a LLP is tantamount to a ‘transfer’ and should be subject to capital gains tax.
Even on the first blush, one fails to appreciate the logic or rationale behind the said grounds of the decision. Briefly said, should one go by the well known and invariably accepted principles of interpretation, founded on related court decisions, neither the Explanatory Memorandum to Finance Bill nor what is envisaged in the LLP Act, as relied upon, could be a factor for decisively forming a correct or better opinion, The point of dispute is, indisputably, a pure and simple question of law; and that has to be necessarily decided, only in accordance with what the Act provides.
Further, in not following, but by distinguishing, the jurisdictional HC’s decision on the point of law the matter of dispute, – to say the least in an inoffensive manner,- the well known principles governing the concept of ‘PRECEDENT’, and the attendant judicial ethics/prudence, have apparently been bypassed.
Be that as it may, even on the first blush, as quickly viewed, either in the cited HC Judgment(s) or in the ITAT case , one important aspect does not seem to have been specifically and sufficiently addressed with full force (open to correction, if factually mistaken); so much so, not been gone into for an insightful consideration.
Reference is to the legal significance / clinching legal import of the crucial expression ‘exchange of the asset’employed in clause (i) of sec 2 (47); which specially defines the concept of ‘Transfer’ in relation to a ‘capital asset’, within its meaning of sec.2 (14).
♦ Aside: In one’s view, the other two expressions used in clause (i), being ‘the sale’, or ‘relinquishment of the asset’, or the expression used in clause (ii) being ‘extinguishment of any rights therein’, could not even remotely be considered to be of any relevance. More importantly, it calls for a conscious noting that, in an arrangement of ‘conversion’, it is the entire ownership interest in the total assets (comprising both capital and other assets and all liabilities- i.e. the net worth of the business in toto,- that gets transmitted to and vests in the LLP; as such, it is the whole of the business, en bloc, to which the LLP succeeds. Precisely stated, in any view, the provisions of the IT Act, particularly those govern and exclusively apply to taxation of ‘capital gains’ in relation to a ‘capital asset’ could not conceivably be invoked to the case of a ‘conversion’ of one form of business entity to another. It needs to be borne in mind, that explains why a transfer, by sale, of the whole business, called ‘’slump sale’ had to be/ hence been covered in a separate provision of the Act.
Further, in this context, it needs to be noted, that the implications of the referred expression have been dealt with, in-depth, in the Bom. HC Judgment (of 1973) in Rasiklal Maneklal’s case, –reported @https://indiankanoon.org/doc/1913191/; albeit in a different context. In one’s conviction / firm belief, had that been cited and relied upon by the assessee, and duly addressed, in the instant ITAT case, the decision might have turned out to be in its favour. This aspect has been dilated herein later.
2.1. LAW – Provisions Of Relevance
(With FONT supplied to sharply focus on)
(A) Clause (xiiib) of sub-sec (1) of Section 47 reads:
Nothing contained in sec 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 57 of the Limited Liability Partnership Act, 2008[6 of 2009.]:
(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 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; 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.]:
The Finance Act 2016 has inserted another clause, w.e.f. 1-4-2017; which reads:
“(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.”
Aside: Before its insertion, which has added one more material condition for sec. 47(xiiib) to apply, the requirement had been in reference to only the size of the company; that is, having its revenue/turnover and gross receipts from business exceeding sixty lakhs rupees.
B) Section 47A (4) (with title head- ‘Withdrawal of exemption in certain cases’) –
(4) Where any of the conditions laid down in the proviso to clause (xiiib) of section 47 are not complied with, the amount of profits or gains arising from the transfer of such capital asset or intangible assets or share or shares NOT CHARGED UNDER SECTION 45 BY VIRTUE OF CONDITIONS LAID DOWN IN THE SAID PROVISO SHALL BE DEEMED TO BE the profits and gains chargeable to tax OF THE SUCCESSOR LIMITED LIABILITY PARTNERSHIP OR THE SHAREHOLDER OF THE PREDECESSOR COMPANY, as the case may be, FOR THE PREVIOUS YEAR IN WHICH THE REQUIREMENTS OF THE SAID PROVISO ARE NOT COMPLIED WITH.
The words in /portions of the enactment highlighted as above, it is believed, may help anyone desirous of making an independent study and critical analysis thereof.
2.2. Own Observations / viewpoints (w.p.r.t. the above quoted enactment, with due emphasis on the words/portions highlighted) are briefly set out below:
A) The principal objective behind the enactment is, as stands to be readily inferred, to clarify that an arrangement entailing conversion of a company to a LLP shall attract no tax on capital gains, either in the hands of the company or its shareholders converted into a LLP (of relevance, are the conditions as per the Proviso (a) and (b)).
B) In several contexts of the quoted enactment, as has been highlighted, the word ‘transfer’ has been quite liberally but loosely used. Obviously, that has been done without realising or overlooking, unwittingly or otherwise, the crucial point that, in order that any arrangement, -such as conversion of a form of legal entity to another as herein, – is rightly regarded as a“TRANSFER” within its specially assigned meaning in sec 2 (47), that must be one of the kind and covered by anyone of the expressions used therein.
In the instant case in which a company is converted into a LLP, for continuing to carry on the business (or profession) as hitherto, from the date of such conversion, there are two possible views:
1) It is the same entity (in form) that converts itself into another (form of) entity; and it is therefore tantamount to a mere change of ‘cloak’ or ‘legal avatar’. And, there are no ‘two parties ‘involved, so as be regarded as a ‘transfer’- in its legal or any other sense.
2) LLP, on conversion, steps into the shoes of the company, and continues to carry on the company’s business. In order to enabling LLP to do so, that has to be concurrently in existence at that point in time.
LLP for coming into being has to first follow the rules of procedure, etc., and have registered as required in terms /accordance with the LLP Act.
If this is regarded as a better of the two views – 1) and 2), then alone the question of examining and deciding- whether or not the arrangement of ‘conversion’ is tantamount to a “TRANSFER” within its special meaning under section 2 (47) of the Act – arises.
Now, reverting to the SC Judgment in Rasiklal Maneklal’s case (supra), the propositions on the legal import of the expression “exchange of a capital asset”, required to be taken as conclusively settled, may be summed up as under:
The said expression, in its natural connotation, involves the transfer by a person of his property to another person; and reciprocally, the latter, in exchange, transfers his property to the former. That is, there must be a mutual transfer of ownership of one thing for the ownership of another.
Thus, in order to be regarded as a ‘transfer’, there must be two properties, concurrently in existence, at the relevant point in time, so as to be exchanged between two parties.
And, in a case in which holder of a property transfers it to another, and the other party , being a company, in return, ‘ISSUES SHARES’ , that cannot be construed as an “exchange of a capital asset”.
And, it is the last mentioned proposition that has been implicitly conceded,and patently accepted with no qualms, and incorporated as well, in the Act itself. That is evidenced by the very enactments in terms of which, mergers and amalgamation of companies, and the shareholders, are exempt from taxation on ‘capital gains’.
Recommend reading the experts’ commentary and cited case law in the Text Book (pgs. 1206 to 1210)
A). The Input supplied above, are in addition to those already shared, on the topic on hand, relentlessly, through several posts on FB and Linkedin; so also on this and other websites, and Google Blogs (personal), available in public domain. Hopefully, these should enable one and all / anyone really concerned to independently study, in proper light; and share thoughts /viewpoints, if any, on the foregoing aspects; also take on with the Government/its Executive to the end of having plugged in suitable correctives (of the lacunae) , at least tentatively, to bring about improvement in the administration of the tax regime
B). This write -up is, as yet, unfinished, with certain more aspects of relevance left uncovered.
Briefly indicated, in the order of relative importance (:
Legality /legitimacy, and constitutional vires / propriety of the restrictive conditions imposed in sec 47 A in general, and in sub-sec (3) and (4) thereof, in particular.
That has to be closely examined in the contexts of,-
the company law (Both Acts of 1956 and of 2013) and LLP Act; and
the scheme of the inter-connected provisions of the IT Act, as presently incorporated, in Chapter IV, under –
D. Profits and gains of business or profession
– Sec.50 B -‘Sale of Whole concern’ (i.e. Slump- Sale)
Sec. 47, r.t.w. Sec 2 (Defns.), –
clauses (14), (17), (31) rtw cl. (23) , (47)- (i) and (ii); And
in Chapter XVI-
Sec.187 to 189A
As personally viewed, and critically analysed, these are the provisions, as presently in force, which are principally responsible, as culprits, for the prevailing chaos and confusion in placing proper construction / interpretation of the connected provisions, resulting in otherwise avoidable disputes and litigation.
C). In the Article published in the print media (Link @ NEW Tax CODE (Spl. Committee)), its author, has broadly pinpointed certain related key areas; done so, obviously hoping that those would receive due attention of the specially appointed Task Force presently engaged on the job of framing a new Tax Code.
The input additionally supplied above, should, in that respct, help in focussing on all such areas which should result in accomplishing a seamless legislative improvement, to eventually fulfil the expectation of betterment of the law, thereby have the scope for fresh litigation reduced to a tolerable level, if not absolutely.
May think of, and if so decided, try and come out with a supplement hereto to cover the rest of the aspects left out as indicated.
NOTE : RESOURCES – worth additionally looking up, in the interim, for an independent critical /in-depth analysis (:
> Transfer X Transmission (Of Property)- Difference ?
> https://indiankanoon.org/doc/6415789/ (Judgment)
> CADD CENTRE VS. ACIT (Judgment)
> Merger of an LLP with a Company – An ‘Evolutionary’ Decision by NCLT (Article @ Taxsutra)
> Conversion of other entities into LLPs and vice versa – MCA
> llp cases – Indian Kanoon