By TIOL News Service

KOLKATA, AUG 13, 2014: THE issues before the Bench are - Whether when a private limited company is converted into a partnership firm and interest free loans are advanced out of the reserves of the erstwhile company in the same ratio as the profit-sharing, it flouts proviso (f) to Sec 47(xiiib) and the assessee is not entitled to the benefit of Sec 47. YES is the Tribunal's answer.

Facts of the case

The assessee firm, Aravali Polymers, LLP, came into existence with effect from August 2010, once the private limited company by the same name was converted into a limited liability partnership under the provisions of sections 56 and 58 of the Companies Act.

The entire undertaking of Aravali Polymers Pvt. Ltd. was dissolved and all its moveable and immovable property, tangible and intangible assets, besides rights and liabilities were transferred to the assessee firm. The assessee had also received the Reserves and Surplus of the dissolved company. The main assets of the dissolved company were shares of East India Hotels which were also transferred to the assesee. The assessee sold these shares, which were offered to tax as long term capital gains and claimed exemption under section 47(xiiib). The assessee had also given interest free loans to its partners, the erstwhile shareholders of the dissolved company, in the same ratio as their profit sharing.

The AO invoked section 47A(4) for computing the capital gains tax adopted the market value of the shares of East India Hotels and after reducing the cost of acquisition, arrived at a higher computation of capital gains. The AO also disallowed the assessee's claim under section 47(xiiib).

On appeal, the Tribunal held that,

++ once the AO 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;

++ 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;

++ this conversion of the private 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 AO, 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 assessee;

++ the crux of the finding in this order is

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

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

• 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 AO.

(See 2014-TIOL-528-ITAT-KOL)