Taxability on Conversion of Private Limited Company To LLP

The LLP is one the popular mode of doing the business in India. The LLP Act has provided to convert a private limited company to LLP. The Income tax Act 1961 also has been amended by inserting the provisions related to such conversion.

When there is transfer, from one person to another person, the transferor has to pay the capital Gain Tax.

The income Tax Act has amended by inserting Section 47(xiiib) which does not amount to transfer. The private limited company which is a transferor and the LLP which is transferee has to comply with the below conditions as per that section.

Extract of Section 47: -Transactions not regarded as transfer.

Nothing contained in section 45 shall apply to the following transfers:—

i)

————-

(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)24: 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 three previous years preceding the previous year in which the conversion takes place does not exceed sixty lakh rupees;

(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; 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 meanings25 respectively assigned to them in the Limited Liability Partnership Act, 2008 (6 of 2009)

The transaction in line with the above provision is not regarded as transfer; hence the conversion can be done without payment of Capital Gain tax.

Consequences If section 47(xiiib) is violated: 

Transfer of capital Assets:

If the above conditions are violated, the transfer of capital asset is to be done at the market rate and accordingly capital gain is to be calculated. The private limited company which is a transferor has to pay the capital gain tax on such transfer.

Transfer of Other Assets:-

The other assets like, stock in trade, current asset etc is also transferred at the market value and the applicable taxes is to be paid.

Impact on Share Holders if section 47(xiiib) is violated

The shares in the hands of the shareholders of the private limited company will be converted as capital of the LLP. The shareholder will surrender the shares and acquire capital in the LLP. The shareholder has to pay tax on the capital gain arising to him from such transfer. The Value of capital is the consideration for the transfer of shares. The cost of share is the amount paid by such share holder at the time of purchase of shares. The receipt of bonus share will not have any cost since it is out of the reserves of the company.

Other Interpretation:

There is one more interpretation that, the transfer of Private Limited Company to LLP is not regarded as transfer. Consequently the shareholders who are transferring the share and the person who is receiving the share are the same. Hence there is no capital gain to be paid by the shareholder because one cannot make profit by selling to himself.

Some ruling on conversion of Private Limited Company to LLP is as under:

1.  ACIT vs. Celerity Power LLP

The honorable Income Tax Appellate Tribunal of Mumbai has held in the above case that:

S. 47(xiiib) r.w.s 47A(4): The conversion of a company into a LLP constitutes a “transfer”. If the conditions of s. 47(xiiib) are not satisfied, the transaction is chargeable to ‘capital gains‘ u/s 45. If the assets and liabilities of the company are vested in the LLP at ‘book values‘ (cost), there is in fact no capital gain. The argument that u/s 58(4) of the LLP Act, the LLP is entitled to carry forward the accumulated losses & unabsorbed depreciation of the company, notwithstanding non-compliance with s. 47(xiiib) is not acceptable.

There are no other rulings available on conversion of Private Limited Company to LLP. However, there are few judgments, where the conversion of the firm to limited liability Company. If the same analogy is brought for the interpretation, it is not a transfer in the hands of the shareholders.

2. Deputy Commissioner of Income Tax vs R L Kalathia and Co

The honorable High Court of Gujarat has held in the above case holds that sale of business of firm as a going concern to limited company for consideration of ‘share capital’ does not amount to transfer liable to capital gains tax; Accepts that even if there was a transfer, it was a slump sale and Sec 45 would not apply to the present case as the entire undertaking has been transferred as a going concern; because there was no transfer of property inasmuch as immovable property cannot be transferred without registration, and in this case there is no registration of such transfer and that there was no transfer as on conversion of the firm to a company the property vests in the same persons in proportion of their interest; (Source: Orange Tax Sutra)

3. Commissioner of Income Tax Vs. Texspin Engg And MFG Works

The Honorable High Court has held that the provisions of Sec. 45(1)/(4) are not attracted even though there was transfer of assets from the firm to the newly constituted company on conversion of firm to company under Part IX of the Companies Act, 1956; Rejects Revenue stand that “on vesting of the properties of the erstwhile firm in the limited company, there was a transfer of capital assets and, therefore, it was chargeable to income- tax under the head “Capital gains” as, on such vesting, there was extinguishment of all rights, title and interests in the capital assets qua the firm.”; Holds that “even if we were to proceed on the basis that vesting in the company under Part-IX constituted transfer under s. 45(1), still the assessee ought to succeed because the firm can be assessed only if the full value of the consideration is received by the firm or if it accrues to the firm. In the present case, the company had allotted shares to the partners of the erstwhile firm, but that was in proportion to the capital of the partners in the erstwhile firm. That allotment of shares had no correlation with the vesting of the properties in the limited company under Part-IX of the Act.” (Source: Orange Tax Sutra)

4. CADD Centre Vs. Assistant Commissioner of Income Tax

Conversion of Partnership Firm into a Limited company, not liable to capital gains u/s. 45(4) – The honorable High Court holds in favour of the assessee and ruled that “when a Partnership Firm is transformed into a Limited Company with no change in the number of partners and the extent of property, there is no transfer of assets involved and hence, there is no liability to pay tax on capital gains”; The firm has only revalued its assets which will not amount to transfer; Provision of Section 45(4) applicable only when the firm is dissolved; Rejects Revenue’s contention that expression “otherwise” occurring in Sec. 45(4) covers cases of capital gains even where there is no dissolution of the firm at all; Notes the twin conditions for Sec. 45(4) to apply – (i) transfer by way of distribution of capital assets, (ii) such transfer should be on dissolution or otherwise (Source: Orange Tax Sutra)

Conclusion:-

The transactions not in covered under section 47(xiiib) is transfer and accordingly capital gain is paid by both the company and the shareholders. However, Based on the above judicial rulings, and case to case basis, one can opine that the Conversion of Private Limited Company to LLP is not taxable neither for Transferor Company nor for the shareholders.

(Republished with Amendments)