Case Law Details

Case Name : Umicore Finance Luxembourg (Authority for Advance Rulings)
Appeal Number : AAR No. 797 of 2009
Date of Judgement/Order : 12/03/2010
Related Assessment Year :
Courts : Advance Rulings

AAR Ruling: No capital gains are accrued or arisen at the time of conversion of partnership into a private limited company under Part IX of the Companies Act, irrespective of subsequent change in the shareholding of such company [Umicore Finance Luxembourg (AAR No. 797 of 2009)].

Facts: Umicore Finance Luxembourg (applicant), incorporated in Luxembourg, was the holding company of its wholly owned subsidiary, Anandeya Zinc Oxides Pvt. Ltd. (Anandeya), an Indian company. Anandeya was incorporated as a private limited company on 13 September 2005 under Part IX and sect6ion 565 of the Companies Act. All the assets and liabilities of the partnership firm, Anandeya Oxides that had been carrying on business w.e.f. 13 September 2005 got vested in Anandeya.

Anandeya Oxides had set up a plant for the manufacture of high purity white seal zinc oxide in 1994 and was converted into a 100% export oriented unit in 1996. The assets of the partnership were revalued for Rs. 5 crores as against the net worth of the business of Rs. 3,05,896 shown in books of account as on 31 March 1998. The excess value of the assets resulting from revaluation was credited to the respective partners’ accounts. On conversion of partnership into a private limited company under Part IX of the Companies Act, the partners of the erstwhile partnership were the same as the shareholders of the company, Anandeya, having share holdings identical with the profit sharing ratio of the 7 partners. There was no revaluation of the assets and liabilities at the time of conversion. Even since the registration of the partnership as company from 13 September 2005, the aggregate of the share holding of the erstwhile partners of the firm in the company has never been less than 51% of the total voting power in the company.

The applicant has acquired entire share capital of Anandeya on 12 August 2008.

The Finance (No. 2) Act, 1998 inserted sub-section (xiii) to section 47 of the Income tax Act (Act) w.e.f. 1 April 1999 which provides that any transfer of a capital asset or intangible asset by a partnership firm to a company as a result of succession of the firm by a company in the business carried on by the firm is not regarded as ‘transfer’, subject to the fulfilment of certain conditions, amongst them one of the conditions is that the aggregate of the shareholding in the company of the partners of the partnership should not be less than 50% of the total voting power in the company and their shareholding should be continued for a period of 5 years from the date of succession. In terms of section 47A, if any of these conditions are not complied with, the amount of profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 45 by virtue of section 47(xiii) shall be deemed to be the profits and gains chargeable to tax in the hands of a successor company.

In view of transfer of shares of Anandeya before the expiry of 5 years from the date of conversion, the parties to the share purchase agreement have entertained a doubt whether the condition of proviso (d) to section 47(xiii) has been violated resulting into capital gains tax in the hands of the company. Therefore, it was stipulated in the share purchase agreement that Anandeya shall pay Rs. 50 lakhs to the income tax department as advance payment towards the possible liability of capital gains arising on the AY 2009- 10 and furnish proof of payment to the sellers.

Issues raised before the Authority for Advance Rulings (AAR):

(a) Whether the conversion of a partnership into a private limited company under Part IX of the Companies Act in September 2005 would be regarded as transfer within the meaning of section 2(47) of the Act.

(b) f so, will it give rise to capital gains liable to income tax consequent upon the transfer of shares in August 2008 and making Anandeya its wholly owned subsidiary by invoking the provisions of proviso (d) to section 47(xiii) of the Act.

Contention of the Applicant: The registration of the firm as a company under Part IX of the Companies Act and consequent vesting of assets in the company did not amount to transfer nor any capital gain had arisen within the meaning of section 45 r.w.s. 48 of the Act and therefore, irrespective of the violation of the condition laid down in proviso (d) to section 47(xiii) of the Act, the liability to pay capital gains cannot be fastened on Anandeya.

AAR Observation and Ruling:

  • Shares allotted to the partners of the extinct firm consequential to the registration of the firm as a company did not give rise to any profit or gain. By receiving such shares the value of which is nothing more than the value of the sum total of their interest in the firm or the worth of their shareholding in the firm, no gain is made They have not become richer to any extent. The rise in the share value in course of time does not have a bearing on the intrinsic worth of shares at the point of time when conversion/succession took place.
  • In a transaction involving the conversion of the firm into company under Part IX of the Companies Act with all assets automatically vesting in the newly registered company as per the statutory mandate contained in section 575, it can hardly be said that the partners have made any gain or received any profit, assuming that there was transfer of capital assets.
  • The worth of the shares allotted to the erstwhile partners was not different from the interest of the partners in the extinct firm when quantified in terms of money.
  • In the case of CIT Vs. Tex spin Engg. Mfg. Works (263 ITR 345)(Bom), the partnership was converted into a limited company under Part IX of the Companies Act during the year 1996- 97 i.e. prior to the insertion of provisions of section 47(xiii). The Revenue took the view that there was a transfer of capital asset by way of dissolution of the firm and therefore, the profits or gains from such transfer became chargeable to tax under section 45(4) of the Act and the difference between the market value and the written down value of the assets transferred to the company would be regarded as capital gains. The Bombay High Court held that the very asset transferred or parted with cannot be the consideration for transfer and therefore, the market value of the asset cannot enter into computation of capital gains. ‘Full value of consideration’ cannot therefore be attributed to the transaction.
  • The AAR observed that although the decision of the Bombay High court was rendered without taking resort to section 47(xiii) and proviso thereto, the basic reasoning underlying the said judgement still holds good.
  • Section 47(xiii) r.w.s 47A(3) cannot be construed to introduce a fiction to the effect that the income which is not liable to be taxed under the other provisions of the chapter on capital gains can be deemed to be capital gains, if the violation of conditions take place. May be, these provisions were introduced on a supposition that the conversion of the firm into company under Part IX of the Companies Act would lead to realisation or profits or gains on account of transfer of capital assets. But section 47A(3) does not achieve the desired objective, as the language of the said provision now stands. Section 47A(3) only emphasises the obvious, that is to say, the profits and gains resulting from the transfer of capital asset chargeable under the provisions of the Act. To judge whether this prerequisite is fulfilled or not, we have to go back to the basic provisions, namely sections 45(1), 48 and 47A(3) cannot be read as a ‘stand alone’ provision.
  • In light of the above, no capital gains accrued or arose at the time of conversion of partnership into a private limited company under Part IX of the Companies Act and therefore, notwithstanding the non-compliance with clause (d) of proviso to section 47(xiii) of the Act, by reason of premature transfer of shares, Anandeya is not liable to pay capital gains tax.
  • No final opinion is expressed in regard to the question whether on the registration of company under Part IX of the Companies Act, there was ‘transfer’ of capital assets.

Our View:

This AAR ruling is a welcome ruling and would be important, especially, in the context of conversion of a partnership firm or a company into a Limited Liability Company (LLP). The Finance Bill, 2010 has proposed that any transfer of a capital asset or intangible asset by a private company or unlisted public company (company) to a LLP on conversion of the company into a LLP in accordance with the provisions of section 56 and 57 of the LLP Act, 2008 would not be regarded as ‘transfer’, subject to fulfilment of certain conditions. However, the Finance Bill, 2010 is silent on the conversion of a partnership firm into a LLP and therefore, the issue would arise whether any transfer of a capital asset or intangible asset by a partnership firm to a LLP would be regarded as ‘transfer’ resulting into capital gains as per section 45 of the Act. If the provisions with regard to conversion of the partnership firm into a Company laid down under Part IX of the Companies Act are interpreted by the Court to be pari materia to those of conversion of the company or partnership firm into a LLP provided under the LLP Act, the benefit of the ratio of the Ruling may be available to the tax payer.

Normally, an advance ruling is sought on the tax liability arising to a non-resident. However, in this Ruling the advance ruling was sought on the tax liability, which has not directly arisen to the non-resident. Thus, the question whether an advance ruling can be sought even on the indirect consequence arising to a non-resident from a proposed transaction was not debated before the AAR. Although the AAR Ruling is applicable only in the case of an Applicant who has sought it, it nevertheless carries a persuasive value

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