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2019 (8) TMI 1641 - AAR - Income TaxAdvance ruling - applicability of capital gains tax in the hands of the shareholders on its conversion from company into LLP - Transfer of shares within the meaning of section 2(47) - whether the computation provision under section 48 of the Act are workable and capable of being implemented, or whether the said provisions would breakdown and fail? - HELD THAT - Whether transfer? - We find from perusal of the 'Memorandum' explaining the purpose and intent behind the enactment of sub-section (xiiib) to Sec. 47, that prior to its insertion, the 'transfer' of assets on conversion of a company into a LLP attracted levy of capital gains tax. The legislature vide the Finance Act, 2010 introduced Sec. 47(xiiib) on the statute, with the purpose that the transfer of assets on conversion of a company into a LLP in accordance with the Limited Liability Partnership Act, 2008, subject to fulfillment of the conditions contemplated therein, shall not be regarded as a 'transfer' for the purposes of Sec. 45 of the Act. In the instant case the cumulative fulfillment of the prescribed conditions has not been satisfied. Therefore, the transaction is a 'transfer' exigible to capital gains tax under the provisions of section 45 of the Act. In view of the specific provisions and also considering the judicial pronouncements as discussed earlier, we have no hesitation in ruling that conversion of the equity shares held by the shareholders in Domino India into partnership interest in Domino LLP, consequent upon the conversion of the company into LLP, was a transfer within the meaning of section 2(47) of the Act. Whether computation provision fails? - 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. In the present case we are concerned with the capital gains arising in the hands of the shareholder and not the company. In the case of shareholder consideration was flowing in the form of partnership interest in the LLP and the capital gain has to be worked out by deducting the cost of acquisition of the shares from the full value of the consideration received. Argument regarding failure of the computation mechanism is also found to be flawed. 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. 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 off with the capital gains in future. Under such a mechanism a neutral capital gain situation may arise which does not render the computation mechanism nugatory and inapposite. Whether value of partner's interest in the LLP is more than the value of shareholder's interest in the company to give rise to any taxable capital gain? - The capital gain has to be worked out by deducting the cost of acquisition of the shares from the full value of consideration of the shares. For the shareholder the full value of consideration for the transfer of shares is his partnership interest in the LLP which might be equal to the value of shareholder's fund in the company - to work out the capital gains, the cost of acquisition of the shares incurred by the shareholder has to be reduced from this full value of consideration. The transaction will certainly give rise to capital gain as one has to reduce the cost of acquisition of the shares from the full value of consideration. Therefore, even if the value of partner's interest in the LLP is equal to the value of shareholder's interest in the company, it does give rise to taxable capital gain in the hands of the shareholder. Ruling - (1) The conversion of the equity shares held by the Applicant shareholder in Domino India into partnership interest in Domino LLP, consequent upon the conversion of Domino India into a Limited Liability Partnership, was a transfer within the meaning of section 2(47) of the Act. (2) On conversion of Domino India into Domino LLP, the computation provision under section 48 of the Act are workable and capable of being implemented for working out the capital gains arising in the hands of the Applicant shareholder. (3) Even if the value of partner's interest in the LLP is equal to the value of shareholder's interest in the company, it does give rise to taxable capital gain in the hands of the Applicant shareholder.
Issues Involved:
1. Whether the conversion of equity shares into partnership interest on conversion of a company into LLP is regarded as a transfer under section 2(47) of the Income-tax Act. 2. Whether the computation provisions under section 48 of the Income-tax Act are workable and capable of being implemented on such conversion. 3. Whether the transaction gives rise to any taxable capital gain if the value of the partner's interest in the LLP is equal to the value of the shareholder's interest in the company. Issue-wise Detailed Analysis: 1. Whether the conversion of equity shares into partnership interest on conversion of a company into LLP is regarded as a transfer under section 2(47) of the Income-tax Act: The Applicant contended that the conversion does not constitute a transfer under section 2(47) of the Act, arguing that it does not fall under the sale, exchange, relinquishment, or extinguishment of rights. However, the Revenue argued that the definition of 'transfer' in section 2(47) is inclusive and covers such transactions. The Authority held that on conversion of a company into LLP, the equity shares are extinguished and replaced by partnership interest, thus constituting a transfer under section 2(47). The Authority referred to section 58(4) of the LLP Act which states that all assets and liabilities of the company are transferred to the LLP, and the company is deemed dissolved. The Authority also relied on the Supreme Court's decision in Grace Collis, which held that extinguishment of rights in a capital asset constitutes a transfer. 2. Whether the computation provisions under section 48 of the Income-tax Act are workable and capable of being implemented on such conversion: The Applicant argued that the computation provisions under section 48 are not workable as no profit or gain arises from the conversion. The Revenue contended that the consideration received by the shareholders in the form of partnership interest is ascertainable and can be valued. The Authority held that the full value of consideration received by the shareholder is the value of the partnership interest in the LLP, and the cost of acquisition is the amount paid for the shares. The Authority stated that the computation mechanism under section 48 is workable, as the value of the partnership interest can be determined from the accounts of the LLP and the erstwhile company. If the value cannot be ascertained, the fair market value as per section 50D should be taken. 3. Whether the transaction gives rise to any taxable capital gain if the value of the partner's interest in the LLP is equal to the value of the shareholder's interest in the company: The Applicant contended that no taxable capital gain arises if the value of the partner's interest in the LLP is equal to the value of the shareholder's interest in the company. The Revenue argued that the consideration received by the shareholder in the form of partnership interest is higher than the face value of the equity shares. The Authority held that the capital gain is computed by deducting the cost of acquisition of shares from the full value of consideration received. Even if the value of the partner's interest in the LLP equals the shareholder's interest in the company, the transaction gives rise to taxable capital gain as the cost of acquisition of shares has to be deducted from the full value of consideration. Conclusion: 1. The conversion of equity shares into partnership interest on conversion of a company into LLP is regarded as a transfer under section 2(47) of the Income-tax Act. 2. The computation provisions under section 48 of the Income-tax Act are workable and capable of being implemented on such conversion. 3. The transaction gives rise to taxable capital gain even if the value of the partner's interest in the LLP is equal to the value of the shareholder's interest in the company.
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