2022 (6) TMI 1276 - AT - Income Tax

Scope of limited scrutiny - Securities premium reserve which stood transferred by the erstwhile company to the assessee-LLP upon conversion as a taxable profit - Whether Assessing Officer travelled beyond the scope of limited scrutiny or not? - HELD THAT - Once a case is selected for limited scrutiny, though the role of the ld. Assessing Officer is confined to examine the issues for which the case is selected for limited scrutiny but then the AO has to go into the depth of such issue and minutely examine the facts attached thereto. AO just cannot casually examine the issue and come to the conclusion because the reasons are just indicative in nature and to reach the depth of the issue raised in the limited scrutiny, AO has to make the examination deeper and deeper examining all the aspects linked to such reason. In case of the complete scrutiny, AO has to examine all the financial transactions carried out by the assessee during the year, whereas in limited scrutiny s issues are limited but the same needs more intense, accurate and deep examination of the issue and facts attached to it. Low income in comparison to high loans/advances/investment in shares - The reason is just an indication for Assessing Officer to examine various aspects. Once the low income is to be examined, it has to be seen in consonance of the higher loans standing in the balance-sheet and in the present case, the interest income is shown only at Rs.14.29 lakhs, whereas the loans and advances are standing to the tune of Rs.13.97 crores. AO went on to examine this aspect of low income, he then asked the assessee about the investment made during the year because the ld. Assessing Officer wanted to see why the assessee has earned low income when there are huge loans and advances. When AO was examining the loans and advances, he came to know that this is the first year of incorporation and the LLP has been converted from the company. AO asked the assessee about the source of investment. Then based on this question, the assessee submitted that the source is the share capital and security premium of the erstwhile company before being converted to LLP and the ld. AO went on to examine the issue of security premium reserve. Second reason for high interest expenditure against new capital added in work - in-progress or addition made to fixed assets and the catch words are high interest expenditure, new capital added which in this case is partner s capital and Reserve Surplus( Security Premium Reserve) - On overall examining the financial statements of the LLP, erstwhile Private Limited Company, the reasons for selecting the case for limited scrutiny which covers various aspects of the assessee including low income, high loans, advances, investment in shares, high interest expenditure, new assets added in work-in-progress and additions in fixed assets, we find that the ld. AO has carried out the assessment proceedings only within the parameters provided under limited scrutiny and has fairly done well by reaching to the depth of the issue and was well within the jurisdiction to examine the source of investment i.e. share capital, Security Premium and unsecured loan of erstwhile Private Limited Company made during the year which were the source of investments fetching very low income. The source of investment as evident from the balance-sheet of LLP, is the share capital and security premium which was carried over from the Private Limited Company. AO has not exceeded the jurisdiction and has not travelled beyond the reasons for selecting the case of the limited scrutiny and ld. Assessing Officer has not done complete scrutiny of the case and has restricted his scrutiny proceedings only with regard to the two reasons mentioned hereinabove for carrying out limited scrutiny. We, therefore, find no merit in the legal issue raised by the assessee in the Cross Objection. The decisions referred and relied upon by the ld. counsel for the assessee and the Instruction of the CBDT referred in the paper book could have been of any help to the assessee only if AO has converted the scrutiny from limited to complete scrutiny, which is not the case before us. The legal issue raised in the Cross Objection filed by the assessee is dismissed. Addition for securities premium reserve which is transferred by the erstwhile company to the assessee- LLP upon conversion as a Reserve Surplus - As the assessee has claimed that all the assets and liabilities of the erstwhile Private Limited Company GDPL has been converted into assets and liabilities of newly incorporated GDLLP and the said conversion is not a transfer u/s. 2(47) of the Act as the proviso (a) to (e) of section 47(xiiib) of the Act are not attracted. In the instant case, clause (a) of the proviso to section 47(xiiib) needs to be examined. Since the Security Premium Reserve of the erstwhile Company was a liability and not eligible to be distributed as dividend to its shareholders, the same needs to carry the same characteristic in the converted LLP. But in the newly formed LLP, the Security Premium Reserve has been shown under the head Reserve Surplus , which for the purpose of GDLLP is a profit available for distribution to its designated partners after three years from the date of said conversion. Now since the nature of liability of Security Premium Reserve is not the same to the nature of liability shown in Reserve Surplus in the newly formed LLP, in our considered view, the assessee s case falls under the proviso (a) and since all the assets and liabilities are not converted into assets and liabilities of the Limited Liability Partnership, the said conversion is a transfer u/s. 2(47) of the Act and provision of section 45 of the Act needs to come into operation. As far as treatment of Security Premium Reserve in the books of newly incorporated LLP is concerned, we observe that Security Premium is not accumulated profit but it is a part of share capital to the extent it was received while issuing in shares by the erstwhile Private Limited Company. Since the Private Limited Company has been converted into a LLP, the only option left for the treatment of the Security Premium Reserve is to bring it to tax in the year in which the Company is converted into LLP. Such Security Premium standing in the balance-sheet at the close of the year before being converted first needs to be brought to tax under the provision of section 56(1) of the Act and then the amount needs to be transferred to Reserve Surplus and which will thereafter be free for withdrawal by the designated partners of the LLP as per the provision of the Act. CIT(Appeals) failed to examine this aspect of the Security Premium Reserve, which the ld. Assessing Officer has rightly observed in the assessment order. We also find merit in the finding of the ld. Assessing Officer for the reason that this issue of examining the treatment of Security Premium Reserve is possible only while examining the case of the assessee for the year in which such conversion takes place. Because if it is not examined in the year of conversion and the balance of Reserve Surplus converted from the Security Premium Reserve is transferred to Reserve Surplus Account and carried forward to subsequent years, then it will not be easy for the revenue authorities to track such adjustment. in view of the options available for utilization of Security Premium Reserve as per the provision of section 52 of the Companies Act, 2013, absence of clear-cut provisions for treatment of such Security Premium Reserve which though is a liability not available for distribution to shareholders of the Private Limited Company, but once the conversion takes place, its treatment in the LLP is only possible by way of treating such Security Premium as income of the LLP under section 56(1) of the Act as income from the other sources and to be brought to tax by crediting it in the Profit Loss Account and debiting the Security Premium Reserve Account, which will bring the Security Premium Reserve balance as NIL and the Reserve Surplus will be the income shown under section 56(1) of the Act and it will be brought to tax in the year when the Private Limited Company is converted into LLP and in the instant case, i.e. A.Y. 2015-16 for which the ld. Assessing Officer has rightly made the addition for the Security Premium Reserve of the erstwhile Private Limited as income of the newly incorporated LLP. We, therefore, reverse the finding of the ld. CIT(Appeals) and confirm the addition made by the ld. Assessing Officer and allow Ground No. 1 raised by the Revenue. Disallowance of expenses - Disallowance includes disallowance of rent and the remaining balance towards salary and other expenditure - So far as the rent expenditure is concerned, the assessee has filed the details of rent paid to Munush Chand HUF which are incurred in cash at Rs.1,72,000/- , which is below the limit provided u/s 194I of the Act. This disallowance of rent expenditure is deleted. As regards the remaining sum same relates to salary expenditure but no details of the same have been filed before the lower authorities. We direct the assessee to furnish the necessary details before the ld. Assessing Officer and if ld. Assessing Officer is satisfied, he can allow the claim in accordance with law. Thus Ground No. 2 is partly allowed for statistical purposes.

Summary

Issues Involved:

1. Whether the Cross Objection filed by the assessee is admissible despite being time-barred by 996 days.
2. Whether the Assessing Officer exceeded the jurisdiction by making additions beyond the scope of limited scrutiny.
3. Whether the securities premium reserve transferred by the erstwhile company to the LLP upon conversion is taxable as income.
4. Whether the disallowance of expenses amounting to Rs.10,00,000/- by the Assessing Officer was justified.

Issue-wise Detailed Analysis:

1. Admissibility of Time-barred Cross Objection:

The Tribunal observed that the Cross Objection filed by the assessee was delayed by 996 days. The assessee claimed the delay was due to a bona fide belief that it was not required to file the Cross Objection. After reviewing the sequence of events and the condonation application, the Tribunal found the delay was not intentional and condoned it, admitting the Cross Objection for adjudication.

2. Jurisdiction of Assessing Officer in Limited Scrutiny:

The assessee contended that the Assessing Officer exceeded the jurisdiction by making additions beyond the scope of limited scrutiny without necessary approval. The Tribunal examined whether the Assessing Officer traveled beyond the limited scrutiny scope. The case was selected for limited scrutiny due to low income compared to high loans/advances/investment in shares and high interest expenditure against new capital added. The Tribunal found that the Assessing Officer stayed within the parameters of limited scrutiny, examining the issues in depth without converting it to complete scrutiny. Thus, the legal ground raised by the assessee in the Cross Objection was dismissed.

3. Taxability of Securities Premium Reserve:

The Revenue appealed against the deletion of the addition of Rs.12,87,23,000/- as taxable income, which was transferred as a securities premium reserve from the erstwhile company to the LLP. The Tribunal noted that the conversion of the company to LLP was governed by section 47(xiiib) of the Income Tax Act, which exempts such transfers from being considered as taxable transfers if certain conditions are met. However, the Tribunal found that the nature of the securities premium reserve changed post-conversion, making it available for distribution to partners, thus not meeting the conditions of section 47(xiiib). Consequently, the Tribunal held that the securities premium reserve should be taxed as income under section 56(1) of the Act. The Tribunal reversed the CIT(A)'s decision and confirmed the addition made by the Assessing Officer.

4. Disallowance of Expenses:

The Revenue also challenged the deletion of the disallowance of expenses amounting to Rs.10,00,000/-. The Tribunal found that the rent expenditure of Rs.1,80,000/- was below the threshold for TDS under section 194I and thus allowable. However, for the remaining salary expenditure, the assessee failed to provide necessary details. The Tribunal directed the assessee to furnish details before the Assessing Officer for verification and allowed the claim if found satisfactory. Thus, this ground was partly allowed for statistical purposes.

Conclusion:

The Tribunal partly allowed the Revenue's appeal, confirming the addition of the securities premium reserve as taxable income and directing further verification for the disallowed expenses. The Cross Objection raised by the assessee was dismissed.