Corporate Updates – 02-08-2014

Case Law

Will benefit of Capital Gain Exemption available to a company during its conversion from a Private Limited Company to a LLP if certain exemption condition is violated??

It is held that advancing of loan to its partners by Limited Liability Partnership out of Reserve and Surplus of erstwhile company results in violation of section 47(xiiib) of the Income Tax Act, 1961. Therefore, the benefit of exemption of capital gain under section 47(xiiib) would not be available to the taxpayer. Accordingly it was held that the capital gain on transfer of assets on conversion of company into LLP is to be computed under Section 45 of the Income Tax Act. (Aravali Polymers LLP v JCIT (I.T.A. No. 718/Kol. / 2014 dated 27.06.2014) (Kol ITAT))

Facts of the Case:

· A Private Limited Company, Aravali Polymers Pvt. Ltd. was converted into a Limited Liability Partnership under section 56 of the erstwhile Companies Act and the Aravali Polymers LLP (Appellant/ Assessee) came into existence.

· 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 at the rate of 10%.

· 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.

· 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).

· The AO observed that 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. AO also held that there was violation of the provisions of section 47(xiiib) and 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 LLP.

· 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.

· Tax Authority’s argued that Proviso (c) to section 47(xiiib) states 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.”

· 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.

· 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.


· Reading the proviso (c) to section 47 gives a meaning that both the Company and the LLP 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. Which clearly shows that there is a violation of proviso (f) to section 47(xiiib). Proviso (f) of section 47(xiiib) having been violated

· 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 sharings hows 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).

· 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 successorLimited Partnership”. The words are not “be deemed to be capital gains chargeable”.

· 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.

· 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 sect ion 45 of the Income Tax Act for which purpose, the issue is restored to the file of the Assessing Officer.

· The appeal of the assessee is partly allowed for statistical purposes.

Kolkata Tribunal held that Capital gains exemption is not available on conversion of a private limited company into an LLP if exemption conditions are violated. Tribunal observed the following:


It is a welcome observation of the Tribunal that the capital gain if any should be computed on the basis of actual transfer value and not on the basis of market value as on the date of conversion. Accordingly if the conversion is made at book value .

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