TaxTMI 
TaxTMI 
2019 (8) TMI 1641
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....y shares were held by the Applicant and the balance two equity shares were held by Domino UK Limited (in the capacity of nominee of the Applicant). Domino India had proposed to be converted into a Limited Liability Partnership (LLP) in accordance with the provisions of Limited Liability Partnership Act 2008 and accordingly an application was filed with the Foreign Investment Promotion Board (FIPB) to obtain the requisite approval for conversion of Domino India from a company to an LLP. On conversion of the company into LLP, the equity shares held by the Applicant in Domino India would be converted into partnership interest in the LLP. The present application has been filed for obtaining a ruling in respect of applicability of capital gains tax in the hands of the shareholders of Domino India on its conversion from company into LLP. The Applicant has raised the following three questions on which a request is made for pronouncement of ruling: - (1) On the facts and in the circumstances of the case, whether conversion of the equity shares held by shareholders in Domino Printech India Private Limited (Domino India) into partnership interest in an India Limited Liability Partne....
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....ino India into Domino LLP cannot be considered as consequent to the 'sale' of shares. It was further submitted that the term 'exchange' requires transfer of property by one person to another and for an exchange transaction, there must exist two persons, as a single person cannot exchange goods with himself. Therefore, the receipt of partnership interest by the Applicant on conversion of Domino India into an LLP cannot be termed as 'exchange'. Regarding the third limb of transfer, it was submitted that 'relinquishment' of an asset is not defined under tax or general law and that by interpreting the terms in the light of judicial pronouncements, whenever a property/asset is relinquished it continues to exist and is owned by some person other than the one who relinquishes the property/assets. According to the Applicant, for a transaction to be categorised as relinquishment of an asset, the following must exist: (a) two parties i.e. the renouncer and a renouncee; and (b) continued existence of the assets, post such relinquishment. It was contended that both these conditions were not fulfilled in the case as subsequent to conversion o....
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....f section 47(xiiib) of the Act which provides that any capital gain arising on transfer of shares held in the company by a shareholder as a result of conversion of company into an LLP shall not be regarded as transfer within the meaning of section 45(1) of the Act subject to fulfilment of specified conditions. One of the specified conditions is that 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. It was admitted by the Applicant that this condition as stipulated in clause (e) of section 47(xiiib) was not fulfilled as the sales/turnover of Domino India in any of the three previous years preceding the year of conversion did exceed the limit of Rs. 60 Lakh. Our attention was also drawn to section 47A(4) of the Act which stipulates for withdrawal of exemption granted under section 47(xiiib) of the Act when the condition laid down in the proviso to that section are not complied with. It was, however, contended that the deeming provision of section 47A(4) of the Act was not absolute. It was submitted that if no profit or gain a....
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.... the scheme of conversion no consideration was flowing to the company. A shareholder of the company got partnership interest in the LLP but it had no co-relation to the transfer of properties by the company to the LLP. Therefore, the computation of capital gain was not possible in such circumstances. 8. The Applicant strongly relied on the judgement of the Bombay High Court in the case of CIT v. Texspin (263 ITR 345) (Bom.)In that case, a partnership firm got registered as a company under Chapter IX of the Companies Act, 1956. The shares of the newly formed company were allotted to the partners of the erstwhile firm, and the question which arose was whether this gave rise to a taxable capital gain in their hands. The High Court held that the vesting of properties in the Company under Chapter IX was a statutory vesting and was not consequent or incidental to a transfer. It was further held that, on such vesting, the cloak given to the firm was replaced by a different cloak and the same firm was now treated as a company, and that this did not constitute a transfer under section 45(1) of the IT Act read with section 2(47). Further, the allotment of the shares to the erstwhile partn....
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....he transaction was a clear case of transfer under the general definition. 11. The revenue further pointed out that the transaction was also specifically covered in Section 2(47) of the Act under "extinguishment of any rights". It was emphasised that the precise question to be decided by the Authority in this case was whether on conversion of the company into LLP; the conversion of shares of the shareholder in the company into partnership interest in the LLP, was transfer or not. It was stressed that when the company gets converted into LLP, the right of shareholders in shareholding of the company (in the form of shares) gets extinguished. Our attention was drawn to Section 58(4) of LLP Act which stipulates that the company shall be deemed to be dissolved and removed from the records of the Registrars of Companies, on its conversion into a LLP. It was submitted that when the company is deemed to be dissolved, the equity shares held by the shareholders get extinguished and thus there was a transfer within the meaning of Section 2(47) of the Act. The revenue has disputed the submission of the Applicant that extinguishment take place only when there is a merger and submitted that me....
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....tation provision u/s 48 of the Act was not workable and not capable of being implemented in the present case, the revenue submitted that in the case of Texspin (supra) the High Court had come to conclusion that there was no profit or gain as there was no consideration qua the transferor. However, in the present case consideration had arisen in the hands of shareholders as they got partnership interest in LLP in return. It was submitted that on dissolution of the company u/s 58(4)(c) of the LLP Act, the shareholders are entitled to get the money's worth of their shares, in the form of the partnership interest in LLP. Further, reliance was also placed on the provision of Section 50(D) of the Act which deems the fair market value on the date of transfer as the full value of the consideration received or accruing as a result of transfer. It was reiterated that as consideration in the form of partnership interest in LLP was flowing, the computation mechanism does not fail. 15. As to the question regarding whether value of partner's right or interest in LLP is more than value of shareholder's interest in the company, the revenue submitted that the decisions as relied upon ....
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....e Luxembourg (supra), which was upheld by the Hon'ble Bombay High Court and has become final. It was further submitted that merely because an assessee is unable to avail of the benefit/exclusion provision, it does not lead to the conclusion that the transaction falls within the charging provision or is taxable. On the reliance of the revenue on section 50D of the Act, it was contended that it was not relevant to decide the issue whether taxable transfer was involved in the conversion of company into a LLP. As regards reliance of revenue on the judgement of the Supreme Court in Grace Collis as well as on the other decisions, it was submitted that the facts of those cases were wholly distinguishable. Findings: 17. We have carefully considered the facts of the case and the submissions of the Applicant as well as the Revenue. The first issue to be decided is whether conversion of the equity shares held by shareholders in Domino India into partnership interest in Domino LLP, consequent upon the conversion of Domino India into a Limited Liability Partnership, is transfer within the meaning of section 2(47) of the I. T. Act. The second related issue to be decided is that on conv....
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....to a capital asset, to include the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law. The definition of 'transfer' in section 2(47) of the Act is an 'inclusive' definition and, therefore, extends to events and transactions which may not otherwise be 'transfer' according to its ordinary, popular and natural sense. The deeming provision of Explanation-2 of section 2(47) stipulates that "transfer" includes disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever. The Applicant has contended that conversion of equity shares held in the company in the partnership interest in the LLP, on the conversion of the company into the LLP, was not covered in the definition of 'transfer' as given in section 2(47) of the Act. It was neither sale nor exchange nor relinquishment of asset nor extinguishment of any right in the asset. There is no dispute about the fact that the Applicant was holding shares in Domino India. On conversion of Domino India into Domino LLP, the shares held by the Applicant in Domino I....
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....th the partnership interest in the LLP. The inclusive definition of transfer in section 2(47) of the Act certainly covers the extinguishment of shareholder's interest on conversion of the company into LLP in its ambit. 21. The Applicant has placed great reliance on the judgement of Hon'ble Bombay High Court in the case of Texspin (supra). It is found that the facts of this case were completely different from the facts of the present case. In the case of Texspin the partnership firm was converted into a Limited Company under Part-IX of the Companies Act, which was specifically covered u/s 45(4) of the Income-Tax Act. The said section stipulated that the profit or gain arising from the transfer of capital asset by way of distribution of capital assets on the dissolution of a firm shall be chargeable to tax as the income of the firm. The precise question to be decided in this case was whether vesting of the erstwhile firm in the limited company was covered by the expression "transfer by way of distribution" in Section 45(4) of the Act. It is in this context that the Hon'ble Court had held that on such vesting the provision of Section 45(4) was not attracted as the very ....
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....read with section 2(47)(ii) which states that transfer in relation to a capital asset shall include extinguishment of any rights therein. The moot point which arose on interpretation of section 45(1) in numerous matters was that on extinguishment of the rights in the capital assets, there was a transfer and in certain cases of reconstitution of firms and introduction of new partners, there was a resultant extinguishment of the rights in the capital assets proportionately. In order to get over this controversy, and keeping in mind the object of encouraging Firms being treated as Companies, the controversy is resolved by the Legislature by introducing clause (xiii) in section 47 with effect from 1st April, 1999. (Emphasis supplied). 23. Thus, it was held by the Hon'ble Court that there was extinguishment of the rights on reconstitution of firms and there was a transfer involved. The same principle applies on conversion of the Company into LLP. The Court had observed that to overcome this impediment and to encourage Firms to be converted into Companies, the Legislature had introduced clause (xiii) in section 47 which stated that where a Firm is succeeded by a company in the bus....
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....on various other decisions wherein the principle of 'change of cloak' as enunciated in the case of Texspin was followed. As the decision of Texspin is not applicable in the present case for the aforesaid reasons, no credence can be given to the decisions following this case, as relied upon by the Applicant. 25. The Applicant has also relied on the observation of the Hon'ble High Court in the case of Texspin (supra) that in the case of a transfer of a capital asset there has to be the existence of a party and a counter party. Such a condition is found not mandatory for charging of capital gains under the provisions of Income-tax Act. The provisions of the Act stipulates for situation where the transferor as well as the transferee can be the same person. As per definition of transfer where the asset is converted by the owner into stock-in-trade of a business carried on by him, such conversion is included in transfer. Further, the provision of Section 45(2) of the Act stipulates that profit arising on transfer by way of conversion of capital asset into a stock in trade is chargeable to tax. Thus, even if the same person changes the nature of his asset it constitutes a t....
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...., a transaction to which section 47(vii) applied and, consequently, the cost to the assessees of the acquisition of the shares of the amalgamated company had to be determined in accordance with the provision of section 49(2), that is to say, the cost was deemed to be the cost of the acquisition by the assessees of their shares in the amalgamating company. The Applicant has contended that the facts of this case were different and, therefore, this decision may not be relied upon. The facts might be different but the meaning of "extinguishment" as propounded in this decision cannot be disputed and has to be followed. The Hon'ble Court has held in this case that there can be extinguishment of rights in a capital asset independent of and otherwise than on account of transfer. And once there is extinguishment of such rights, it is deemed to be transfer under the provisions of section 2(47) of the Act. As held by the Apex Court the rights of the shareholder in the shares of the amalgamating company were extinguished upon the amalgamation of the amalgamating company with the amalgamated company. Following the same principle, the rights of the Applicant in the shares of Domino ....
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....o held that the definition of words "transfer" under Section 2(47) of the Act was not an exhaustive definition and that sub-section (1) of clause (47) of Section 2 implies that parting with any capital asset for gain would be taxable under Section 45 of the Act. It has also been held by the AP High Court in the case of Trustees of H.E.H. The Nizam Second Supplementary Family Trust (102 ITR 248) that conversion of preference shares into ordinary shares was transfer by way of exchange within meaning of section 45 of the Act. 30. When a company is converted into LLP there is transfer of assets not only by the company to the LLP but also transfer of shares held in the company by the shareholder. In the present case we are not concerned with the transfer of assets by the company but only with the transfer of shares held in the company by the shareholder. The LLP was incorporated in the taxation scheme of India effective from the 1st day of April 2010 i.e., assessment year 2010-11 on the same lines as the taxation scheme for general partnerships, i.e., taxation in the hands of the entity and exemption from tax in the hands of its partners. An LLP and a general partnership was treated ....
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.... (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 meanings respectively assigned to them in the Limited Liability Partnership Act, 2008 (6 of 2009); (emphasis supplied). 31. It is thus crystal clear from the above provisions of the Act that transfer of a capital asset or intangible asset by a company to a LLP 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 was a transfer, to which provisions of section 45 of the Act regarding c....
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.... 'Capital gains' and shall be deemed to be the income of the previous year in which the transfer took place. Section 47 excludes certain transactions from the levy of capital gains tax and lays down that nothing contained in Section 45 shall apply to the 'transfers' mentioned therein. Clause (xiiib) of Section 47 stipulates that transfer of a capital asset or intangible asset by a company to a LLP or transfer of shares held in the company by a shareholder, as a result of conversion of the company into LLP in accordance with the provision of section 56 or 57 of the LLP Act 2008, will be excluded from the purview of section 45, subject to fulfilment of the conditions as mentioned in the proviso therein. Thus, the transactions referred in section 47 are "transfers". However, they fall beyond the sweep of chargeability of capital gains tax u/s 45 of the Act subject to cumulative satisfaction of the conditions prescribed therein. There is no doubt about the position that prior to insertion of clause (xiiib) of Section 47 such transaction was subject to capital gains tax. In the present case all the conditions as stipulated in the proviso to section 47(xiiib) have not bee....
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.... full value of consideration of the shares in the transfer pursuant to conversion of Domino India into Domino LLP and also the cost of acquisition of those shares. 35. On the conversion of a company into a LLP, the shares in the hand of the share-holders of the company are converted into capital in the LLP. Thus, the shareholders relinquish their shareholding in the company and acquire capital in the LLP in the same proportion as was the shareholding in the private limited company. The full value of the consideration received/accrued to each shareholder, as a result of relinquishment of shares, will be the Value of the Capital in the newly formed LLP for the purpose of computation of Capital Gains under section 48 of the Act. If any of the shareholders of the private limited company receives any extra consideration or benefit, directly or indirectly, in any form or manner, the full value of the consideration received has to be enhanced accordingly for the purpose of computation of capital gains under section 48 of the Act. Further, necessary adjustments also has to be made to the full value of the consideration, if the capital contribution and profit sharing ratio in the limited....
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....value of the shares foregone by the Applicant considering the reserves and surpluses transferred. The full value of consideration of the shares foregone by the Applicant can be worked out from the accounts of the LLP and the erstwhile company. If the value of partnership interest cannot be ascertained or determined for any reason, then the fair market value of the same has to be taken as stipulated under section 50D of the Act. 37. The Applicant has contended that the value of partnership interest in LLP was equal to the value of shareholder's interest in the company. In other words, the cost of acquisition of the partner's interest in the LLP was deemed to be the cost of acquisition of the shares held in the company and, therefore, the transaction does not give rise to any taxable capital gain and the computation mechanism fails. Such an interpretation is contrary to the computation mechanism of capital gains as prescribed in the Act and as discussed above. The meaning of 'cost of acquisition' is defined in section 55(2) of the Act which does not stipulate that the cost of acquisition of the partner's interest in the LLP, will be deemed to be the cost of acq....
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....st of acquisition, it will result in capital gains. (b) If the full value of consideration is less than the cost of acquisition, it will result in capital loss. (c) If the full value of consideration is equal to the cost of acquisition, it will have neither gain or loss and will be tax neutral. Simply because in a case there is no gain or loss due to full value of consideration being equal to the cost of acquisition, we can not say that the computation mechanism fails. The computation mechanism encompasses a situation which may be tax neutral. The mechanism is meant not only to tax the capital gains but it allows carry forward of the capital loss and their set off with the capital gains in future. In such computation mechanism, a neutral capital gains situation may arise but that does not render the computation mechanism otiose. 40. In the case of Texspin (supra), relied upon by the Applicant, the Hon'ble Court had held that section 45(4) was mutually exclusive to section 45(1) and the stipulation in section 45(4) that A.O. was entitled to treat the market value of the asset on the date of transfer as full value of the consideration received was missing ....
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.... to levy the capital gains tax. It was further held that in a transaction involving the conversion of firm into Company under Part-IX of Companies Act, with all the 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, as 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. The transaction did not give rise to any profit or gain as the value of shares was nothing more than the value of the sum total of their interest in the firm or the worth of their shareholding in the firm. It was ruled that no capital gains accrued or arose at the time of conversion of partnership firm 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 Income-tax Act, by reason of premature transfer of shares, the said company was not liable to pay capital gains tax. This ruling was upheld by the Hon'ble Bombay High Court. 42. It can ....
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.... of a Company. The Company has an independent legal entity, de hors its share-holders, whereas the Partnership Firm has not such independent existence, de hors the partners. Therefore, 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 Hon'ble court held in this case that the company has an independent legal entity de hors its shareholders whereas the partnership firm has no such independent existence de hors its partners. In the present case we are concerned with the capital gain arising in the hand of the shareholder which has to be independently computed de hors the capital gain arising in the hands of the company. As held by the Court the liability of the partner is different from that of the liability of a shareholder director. Therefore, the decision as given in the context of the conversion of firm into company cannot be applied to the case of a shareholder. 45. In the case of Ravishankar R Singh (supra) the issue was conversion of firm into company and the Hon'ble Bombay High C....
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..... It was further held that as the assets and liabilities of the erstwhile company got vested in the LLP at their book value, such book value could only be regarded as the full value of consideration for the purpose of computation of capital gains. 49. In the light of above discussions we are of the considered view that the computation mechanism under section 45 read with section 48 of the Act is workable and capable of being implemented in the present case. The full value of consideration for the purpose of computation of capital gains will be the value of the Applicant's partnership interest in Domino LLP and the cost of acquisition of shares shall be the amount paid by the Applicant share holder at the time of purchase of shares. The Applicant's partnership interest in the LLP is capable of being evaluated on commercial and accounting principles and if it cannot be done so their fair market value has to be taken as stipulated u/s 50D of the Act. Further, the computation mechanism of the capital gains does not break down or fail as the scheme envisages for not only taxing the capital gains but also allows carry forward of the capital loss incurred, if any, and their set....