Case Law Details

Case Name : Aravali Polymers LLP Vs Joint Commissioner of Income Tax (ITAT Kolkata)
Appeal Number : I.T.A. No. 718/Kol./2014
Date of Judgement/Order : 27/07/2014
Related Assessment Year : 2011- 2012
Courts : All ITAT (5511) ITAT Kolkata (442)

Conversion To LLP – Capital gains to be computed on book value of assets transferred and not on market value

A perusal of the provisions of section 45 of the Income Tax Act shows the levy of capital gains to be on the profits or gains arising from the transfer of capital asset effected in the previous year. Admittedly, the erstwhile Company Aravali Polymers Pvt. Ltd. converted into a partnership firm Aravali Polymers LLP, a Limited Liability Partnership firm. This took place on 12.08.2010 being the assessment year under appeal. This conversion of the Pvt. Limited Company into a Limited Liability Partnership does not have the protection of section 47(xiiib) in the assessee’s case. Consequently the capital gain on the same is liable to be considered. In the computation of capital gains, nowhere in the Act is there provision, more so in section 45, for deeming the sale price in the case of equity shares. The value at which the shares or the assets of the Company Aravali Polymers Pvt. Ltd. was taken over by the Limited Liability Partnership firm, would be the sale price and the cost of acquisition thereof is to be as per books of the erstwhile Company. In these circumstances, the issue of computation of the capital gains under section 45 is restored to the file of the Assessing Officer, who shall take the sale consideration as on 12.10.2010 at the figure, at which the assets of the erstwhile firm has been acquired or taken over by the appellant Aravali Polymers LLP.

INCOME TAX APPELLATE TRIBUNAL,
KOLKATA ‘C’ BENCH, KOLKATA

Before Shri Shamim Yahya (Accountant Member),
and Shri George Mathan (Judicial Member)

I.T.A. No. 718/Kol. / 2014
Assessment year : 2011-2012

Aravali Polymers LLP

-Vs.-

Joint Commissioner of Income Tax

Date of pronouncing the order : June 27, 2014

ORDER

Per George Mathan:

This is an appeal filed by the assessee against the order of ld. Commissioner of Income Tax (Appeals)-XX, Kolkata in Appeal No. 242/CIT(A)-XX/Range-34/2013-14/Kol. dated 11.04.2014 for the assessment year 20 11-12.

2. Shri R.N. Bajoria, Senior Advocate alongwith Shri A.K. Gupta, FCA, represented on behalf of the assessee and Shri Ravi Jain, CIT, D.R., represented on behalf of the Revenue.

  1. In assessee’s appeal, assessee has raised the following grounds:-

(1) For that the Commissioner of Income Tax (Appeals) erred in confirming the order of assessment in its entirety without discussing and dealing with any of the arguments raised by the appellant in the grounds of appeal as well as advanced in course of hearing before him and passed a non-speaking order which is illegal and liable to be cancelled.

(2)  For that the CIT(A) erred in not discussing and deciding at all grounds no. 4 to 8 and as such the order passed by him is arbitrary, erroneous, illegal and perverse.

(3)  For that the CIT(A) erred in holding that the provisions of section 47(xiiib) of the Income Tax Act, 1961 (in short “the Act”) have not been complied with and as such the capital gains tax exemption on conversion of a private limited company to an LLP was not available to the appellant.

(4) For that advancing of loans to the partners cannot tantamount to distribution and/or payment to the partners and the provisions of clause (c) and (f) of proviso to section 47(xiiib) of the Act were not attracted due to such advance made to the partners and CIT(A) should have held that the benefit under section 47(xiiib) of the Act was available to the appellant.

(5)  For that CIT(A) did not appreciate the fact that the cost at which the shares of EIH Ltd. were acquired by the appellant on conversion was accepted by the AO in the order of assessment for the purpose of computing capital gains returned by the appellant and as such the sale consideration for transfer of the said shares to the appellant in the hands of the transferor i.e. erstwhile Private Limited Company could not be different under any circumstances.

(6)   For that the CIT(A) failed to appreciate that there was no provision in the Income Tax Act, 1961 under which the consideration for the shares of the EIH Limited and/or the business alleged to have been transferred by the erstwhile Private Limited Company could be substituted for market value for the purpose of computing the capital when admittedly the said shares and/or the said business was transferred at cost as appearing in the books of account of the erstwhile Private Limited Company and was also accounted for at cost in the books of the appellant i.e. transferee and as such the charging of tax on alleged capital gain of Rs.38,47,60,031/- was erroneous and illegal.

(7) For that further and in any event and without prejudice to the above and for the sake of argument even it is assumed that the whole business was transferred at the market value on 12.08.2010 by the erstwhile Pvt. Ltd. Company and the said value could be substituted for the purpose of computing the capital gain then in that event that value of 12.08.2010 will become the cost of the appellant and the computation of capital gain on the subsequent actual sale of shares of EIH Ltd. by appellant could only be determined with reference to such enhanced cost.

8. For that further and in any event and without prejudice to the above:

(i)  the computation of capital gain by the AO by suo moto granting the benefit of indexation and charging the tax @ 20% is erroneous and illegal and the capital gain should have been calculated with reference to the actual cost and tax on the same should be charged @ 10%.

(ii) the computation of capital gain of Rs.92,94,29,909/- as against the total market value of the said shares computed by the AO himself in the order of assessment at Rs.42,74,09,099/- is erroneous, illegal and perverse.

9. For that the CIT(A) erred in confirming the action of the AO in disallowing the legal expenses as capital in nature.

10. For that the appellant denies its liability to pay any interest under section 234B and 234C of the Act.

  1. In the course of hearing, it was submitted by the ld. Counsel for the assessee that the Ground No. 1 of the assessee’s appeal is not pressed. Consequently, Ground No. 1 of the assessee’s appeal stands dismissed.

5. It was the further submission by the ld. Counsel for the assessee that a Private Limited Company namely Aravali Polymers Pvt. Ltd. was converted into a Limited Liability Partnership under section 56 of the Companies Act and the assessee Aravali Polymers LLP came into existence  on August 13, 2010. It was the submission that as per the provisions of section 58(4) of the Companies Act, all the tangible, movable, immovable and intangible property as also all assets, interest, rights, privileges, liabilities and obligations, in effect whole of the undertaking of Aravali Polymers Pvt. Ltd. stood transferred to and vested in the appellant M/s. Aravali Polymers LLP and Aravali Polymers Pvt. Ltd. was deemed to be dissolved. It was the submission that the main assets in the Pvt. Limited Company Aravali Polymers Pvt. Ltd. was 31,80,000 shares of East India Hotels Ltd. It was the submission that after the conversion of the Private Limited Company into the appellant Limited Liability Partnership, 31,84,807 equity shares of the East India Hotels Ltd. was sold by the appellant for an amount of Rs.53,56,69,888/- and the same was offered for taxation as long-term capital gains. The capital gain was leviable at 10%. It was the submission that after paying the capital gains tax, the assessee had approximately Rs. 49 crores profit. The assessee had also received Reserves and Surplus amounting to Rs.3,06,31,969/- of the Private Limited Company. The assessee had given an amount of Rs.50 crores as interest-free loans to the partners of the appellant-firm. When the assessee filed its return, the assessee had offered the capital gains on the sale of the equity shares of East India Hotels Ltd. and had also claimed exemption under section 47(xiiib). In the course of assessment on the ground that the assessee had provided interest-free loan to the partners of the assessee-firm out of the Reserve and Surplus received by the assessee firm on the conversion of the Pvt. Limited Company into the Limited Liability Partnership, the Assessing Officer had held that there was violation of the provisions of section 47(xiiib) and had consequently held that in view of the provisions of section 47A(4), the amount of profit and gains arising from the transfer of the capital assets or shares is to be profit and gains chargeable to tax on the assessee-firm being the successor Limited Liability Partnership. It was the submission by the ld. A.R. that consequently the Assessing Officer had adopted the value of the shares in East India Hotels Ltd. held by the Pvt. Limited Company and transferred to the assessee-firm as liable to be valued at market price as on the date of the transfer. Consequently the Assessing Officer had adopted the market value as on 12.08.2010 at Rs.132.40 per share thereby arriving at a market value of Rs.42,74,01,099/-. From the market value he reduced the cost of acquisition and arrived at a capital gains of Rs.38,47,60,021/-. It was the submission by the ld. Sr. Counsel that at the outset there was no violation of the provisions of section 47(xiiib) in so far as a loan is a receivable and no benefit had been given to the partners. It was the submission that the allegation of the Assessing Officer was that by giving the loan the assessee had violated sub-clause (c) & (f) of the proviso to section 47(xiiib). It was the submission that no benefit having been received by the shareholders of the erstwhile company and no amount was paid to any partner out of the balance of the accumulated profits standing in the accounts of the Company as on the date of the conversion. It was the further submission that even assuming there was a violation of the proviso to section 47(xiiib), the computation of capital gains as made by the Assessing Officer was wrong in so far as there is no provision for deeming the market price of the shares or the assets, especially when the asset has been transferred at book value. There was no provision for deemed cost in respect of the assets transferred and it was only the actual value on which the asset was transferred which could be considered. It was also the alternate submission that even assuming a value is provided to the asset, then it is that value which would have been considered as a cost acquisition in the hands of the assessee, especially when the said asset representing shares of East India Hotels Ltd. had been sold by the assessee and capital gains had also been offered to tax and that calculation of the capital gains had been accepted by the Assessing Officer, in effect accepting the cost of acquisition at book value. It was the submission that the cost of acquisition for the purpose of computing the capital gains in the hands of the assessee having been accepted at a particular figure that figure could not be tinkered with for the purpose of computing the profits and gains arising from the transfer of the capital assets or shares for the purpose of section 47A(4) of the Act. It was the submission that the order of the ld. CIT(Appeals) was liable to be reversed and the addition as made by the Assessing Officer on account of the alleged violation of the provisions of section 47(xiiib) was liable to be deleted.

  1. In reply, ld. CIT, D.R. submitted that the words used in the proviso (c) to section 47(xiiib) are that “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.”. It was the submission that the loan having been given to the partners of the assessee-firm who are none other than the shareholders of the erstwhile company, is, in fact, a benefit and such benefit had been given in the form of interest-free loans. It was the further submission that the assessee having used a part of the Reserves and Surplus, which was transferred from the erstwhile company to the assessee-firm, had been paid directly to the partners of the assessee-firm. It was the submission that there was a total violation of the provisos (c) and (f) to Section 47(xiiib) and consequently the provisions of section 47(xiiib) stood violated and the profits and gains arising from the transfer of the shares of East India Hotels Ltd. was liable to be assessed as per Section 47A(4). It was the submission that the issue of the computation of capital gains was not an issue decided by the ld. CIT(Appeals) and consequently the issue of the computation was not liable to be considered by the Tribunal. It was the submission that the order of the ld. CIT(Appeals) and that of the Assessing Officer was liable to be upheld.
  2. We have considered the rival submissions. The following facts emerged from the submissions made on behalf of the assessee and the revenue:-

(i) Aravali Polymers Pvt. Ltd., a Pvt. Limited Company, was converted into a Limited Liability Partnership as per the provisions of sections 56 & 58 of the Companies Act, 2008 w.e.f. 12th August, 2010. 12.08.2010 relates to the assessment year 20 11-12, which is the year under appeal. Aravali Polymers Pvt. Ltd. held 3 1,84,807 shares of East India Hotels Ltd., which was transferred to the assessee-firm. Aravali Polymers also had Reserves and Surplus to an extent of Rs. 3,06,65,298/- as on 12.08.2010, the date of conversion into the appellant firm. The appellant firm had sold 3,00,000 shares received by it of East India Hotels Ltd. for a consideration of Rs. 53,56,69,888/- and the assessee- firm had paid capital gains tax on the same and was left with about Rs.49.3 crores.

(ii) The assessee-firm had given interest-free loans to its partners to an extent of Rs.50 crores. The loan was given to the partners in the same ratio as that of profit sharing.

8. With these facts it would be worthwhile to extract the provisions of Section 47(xiiib) along with the proviso thereunder, which is as under:-

47(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 tree 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 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).

Further Section 47A(4) reads as follows:-

“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”.

9. A perusal of the proviso (c) to section 47(xiiib), the first question that comes to mind is that the assessee has made a claim under section 47(xiiib), the Assessing Officer denies such a claim. Once the Assessing Officer has denied the assessee’s claim of section 47(xiiib) in the initial year itself, will the provision of section 47A(4) come into play or is it directly under the control of section 45 in respect of the levy of capital gains. Admittedly the assessee has given a loan to the erstwhile shareholders. However, the proviso (c) to section 47 talks of the shareholders of the Company to not-receive any consideration or benefit directly or indirectly in any form or manner other than by way of shares in profit and capital contribution in the Limited Liability Partnership. A reading of the said proviso (c) gives a meaning that both the Company and the Limited Liability Partnership must exist for the shareholders of the Company to receive any consideration. Admittedly, in the present case, the Company does not exist after conversion. Therefore, the question of a violation of Proviso (c) to Section 47(xiiib) does not exist.

Coming to the proviso (f) to Section 47(xiiib), it bars payment either directly or indirectly to any partner out of the 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. Here the assessee-firm gave loans to its partners. This loan, more so a part of the loan, has been paid out of the Reserves and Surplus of the erstwhile Company which, in fact, represents the accumulated profit standing in the accounts of the erstwhile Company. The fact that the loan has been paid, it is an interest-free loan coupled with the fact that the loan has been given to its partners in the same ratio as profit sharing shows that the amount has been given directly to the partners out of the balance of the accumulated profits standing in the accounts of the Company on the date of conversion. It clearly shows that there is a violation of proviso (f) to section 47(xiiib). Proviso (f) of section 47(xiiib) having been violated the benefit of the provisions of section 47, which deems certain transactions to be not regarded as transfer stands violated.

10. However, when the Assessing Officer invoked section 47A(4), he proceeded to compute capital gains in respect of the shares of East India Hotels Ltd. A perusal of the provisions of section 47A(4) uses the words “shall be deemed to be the profits and gains chargeable to tax of the successor Limited Partnership”. The words are not “be deemed to be capital gains chargeable”.

  1. A further reading of the provisions of section 47A(4) shows that it is when there is a violation of the provisions of section 47(xiiib), more so when the conditions laid down in the proviso to clause (xiiib) of section 47 are not complied with. This meaning that the provisions of section 47(xiiib) were already available to the assessee and the proviso thereunder that to have been violated. In the present case, the assessment year under appeal is the year on which the conversion took place and in that year itself, the conditions prescribed for the benefit of section 47(xiiib) were not complied with and consequently the provisions of section 47(xiiib) were not available to the assessee, then where is the non-compliance of the proviso to section 47(xiiib) to attract 47A(4). It is in such circumstances that section 45 comes into play as section 47(xiiib) itself is not applicable to the assessee.

12. A perusal of the provisions of section 45 of the Income Tax Act shows the levy of capital gains to be on the profits or gains arising from the transfer of capital asset effected in the previous year. Admittedly, the erstwhile Company Aravali Polymers Pvt. Ltd. converted into a partnership firm Aravali Polymers LLP, a Limited Liability Partnership firm. This took place on 12.08.2010 being the assessment year under appeal. This conversion of the Pvt. Limited Company into a Limited Liability Partnership does not have the protection of section 47(xiiib) in the assessee’s case. Consequently the capital gain on the same is liable to be considered. In the computation of capital gains, nowhere in the Act is there provision, more so in section 45, for deeming the sale price in the case of equity shares. The value at which the shares or the assets of the Company Aravali Polymers Pvt. Ltd. was taken over by the Limited Liability Partnership firm, would be the sale price and the cost of acquisition thereof is to be as per books of the erstwhile Company. In these circumstances, the issue of computation of the capital gains under section 45 is restored to the file of the Assessing Officer, who shall take the sale consideration as on 12.10.2010 at the figure, at which the assets of the erstwhile firm has been acquired or taken over by the appellant Aravali Polymers LLP.

13. In the result, the crux of the finding  in this order is –

(i)   The assessee has not complied with the proviso to section 47(xiiib). Consequently the benefit of section 47(xiiib) is  ot available to the assessee.

(ii)  As the assessee did not have the benefit of section 47(xiiib), the provision of section 47A(4) does not apply.

(iii)  The capital gains in respect of the transfer of the assets in the hands of M/s. Aravali Polymers Pvt. Ltd. to the appellant firm Aravali Polymers LLP is to be computed under section 45 of the Income Tax Act for which purpose, the issue is restored to the file of the Assessing Officer.

14. In the result, the appeal of the assessee is partly allowed for statistical purposes.

Order pronounced in the open Court on 27th June, 2014.

Download Judgment/Order

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Category : Income Tax (28359)
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Tags : ITAT Judgments (5690) LLP (239)

0 responses to “LLP Conversion: Capital gain to be computed on book value”

  1. vswami says:

    At the first blush, subject to an independent study in-depth, the point of controversy as settled by the first appellate authority is noted to essentially bring to the fore one important thing: The extant applicable provisions gone into by the itat are not so clear as to lend scope for a straightforward reading and intelligible interpretation of the law. As such, the matter,it is anybody’s guess as to what view would be finally taken, if, as is likely,pursued in further proceedings. No need to add that,now it is in the representing counsels’ court to put up all possible pleas only after making an incisive study, in order to ensure that the final opinion eventually handed out, by any yardstick, comes to prove a logically right or better view,in its profound sense.

    Meanwhile, it is worthwhile for the law and finance ministries to probe into and decide how best the extant provisions could be modified so as to bring about clarity; as that should save from a protracted litigation and be for the common good.

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