2010 (3) TMI 112 - AAR - Income Tax

Transfer of asset - whether the conversion of partnership firm as a private limited company under Part-IX of the Companies Act, 1956 in September, 2005 will be regarded as transfer within the meaning of section 2(47) and other relevant provisions of the Income-tax Act, 1961? If so, will it give rise to capital gains liable to income-tax consequent upon the transaction entered into by the applicant of buying the shares of the said company in August, 2008 and making it its wholly owned subsidiary by reason of the provision in clause (d) of proviso to section 47(xiii) of the Act? Held that - Though we are not inclined to express a final opinion on the point of transfer, we would like to say this much Section 47(xiii) read with Section 47A(3) cannot be construed to introduce a fiction to the effect that the income which is not liable to be taxed under the other provisions of the Chapter on capital gains can be deemed to be capital gains, if the violation of conditions take place. May be, these provisions were introduced on a supposition that the conversion of the firm into company under Part IX of the Companies Act would lead to realization of profits or gains on account of transfer of capital assets. But, S.47A(3) does not achieve the desired objective, as the language of the said Provision now stands. Section 47A(3) only emphasizes the obvious, that is to say, the profits and gains resulting from the transfer of capital asset chargeable under the Provisions of the Act.. To judge whether this prerequisite is fulfilled or not, we have to go back to the basic provisions, namely Section 45(1) and Section 48 and S.47-A(3) cannot be read as a stand alone provision. 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 is not liable to pay capital gains tax.

Issues Involved:

1. Whether the conversion of a partnership firm into a private limited company under Part-IX of the Companies Act, 1956, constitutes a "transfer" within the meaning of section 2(47) and other relevant provisions of the Income-tax Act, 1961.
2. Whether such conversion gives rise to capital gains liable to income-tax due to the transaction of buying shares and making the company a wholly-owned subsidiary, considering the provision in clause (d) of the proviso to section 47(xiii) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Conversion as "Transfer" under Section 2(47) of the Income-tax Act, 1961:

The applicant, a non-resident company, purchased the entire shareholding of an Indian company, Anandeya Zinc Oxides Pvt. Ltd. ('Anandeya'), which was originally a partnership firm converted into a private limited company under Part-IX of the Companies Act, 1956. The question was whether this conversion is regarded as a "transfer" under section 2(47) of the Income-tax Act, 1961.

The relevant provisions of Part-IX of the Companies Act, 1956, and sections 45, 47, 47A, and 48 of the Income-tax Act, 1961, were examined. Section 575 of the Companies Act provides for the statutory vesting of property upon registration. The Andhra Pradesh High Court in V.P. Rao v/s Sri Ramanuja Ginning & Rice Factory interpreted that a partnership firm could be treated as a company for registration purposes under Part-IX.

The Bombay High Court in CIT v/s Texspin Engg. & Mfg. Works [263 ITR 345] held that conversion under Part-IX does not constitute a transfer as there is no conveyance of property executable in favor of the limited company. The firm merely gets a new cloak as a company, and there is no transfer of capital assets as contemplated by section 45(1).

2. Capital Gains Tax Liability due to Premature Transfer of Shares:

The applicant argued that the conversion did not result in a transfer or capital gain within the meaning of section 45 read with section 48. The conversion met the conditions of section 47(xiii) except for clause (d), which requires the shareholding of the erstwhile partners to remain above 50% for five years. The premature transfer of shares before this period led to a potential capital gains tax liability under section 47A(3).

Section 47A(3) states that non-compliance with conditions in the proviso to section 47(xiii) results in the profits or gains from the transfer being deemed taxable. However, the ruling emphasized that for section 47A(3) to apply, there must be actual profits or gains from a transfer. The ruling relied on the Texspin case, which held that the partners did not gain any profit or become richer through the conversion, as the value of shares received was equivalent to their interest in the firm.

The ruling concluded that no capital gains accrued at the time of conversion, and thus, the company was not liable to pay capital gains tax despite the premature transfer of shares. The ruling did not express a final opinion on whether the registration of the company under Part-IX constituted a "transfer" of capital assets.

Judgment:

The ruling concluded that the conversion of the partnership firm into a private limited company did not result in capital gains liable to income-tax, notwithstanding the non-compliance with clause (d) of the proviso to section 47(xiii) due to the premature transfer of shares. The company was not liable to pay capital gains tax.

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