2016 (12) TMI 360 - HC - Income Tax

Conversion of the partnership firm into a Private Limited Company - premature transfer of shares - revocation of exemption from Capital gains tax - Held that - AAR has in a very reasoned Order, has taken a view that no capital gains accrued or attracted at the time of conversion of the partnership firm into a Private Limited Company. In part IX of the Companies Act, therefore, notwithstanding the non-compliance with clause (d) of the proviso of Section 47(xiii) of the Income Tax Act by premature transfer of shares, the said Company is not liable to pay capital gains tax. These findings have been arrived at essentially looking into the fact that there was revaluation of assets at the time of conversion of the firm M/s. Anandeya Zinc Oxides Private Limited. The said finding of fact has not been disputed by the learned Counsel appearing for the Petitioners and, as such, the finding of the learned AAR that there was no capital gains in the transaction in question cannot be faulted. It is also to be noted that even immediately after such conversion in question from the partnership firm into a Private Limited Company, the assessment with regard to the income of the new Company as well as of the respective partners were filed and there was no objection or grievances raised by the Assessing Officer that any capital gains had to be paid on account of the incorporation of the Company in terms of the said provisions. The transfer of shares in favour of the Respondent by the erstwhile partners who were shareholders of M/s. Anandeya Zinc Oxides Private Limited and such partners/share holders are liable to pay capital gains even if acceptable, would not affect the decision passed by the learned AAR whilst coming to the conclusion that there were no capital gains at the time of incorporation of the new Company by the said partnership firm. The contention of the Petitioner that in view of the violation of clause (d) of Section 47(xiii), the exemption from capital gains enjoyed by the Assessing firm upon conversion into a Private Limited Company, ceases to be in force cannot be accepted. We have already examined that there are no capital gains which have accrued on account of such incorporation. In such circumstances, we find that the said contention of the learned Counsel appearing for the Petitioner that in view of the transfer of the capital assets or intangible assets, there are capital gain tax payable by the transferee Company, cannot be accepted. As pointed out herein above, there was no capital gains payable at the time of the incorporation of the Company from the erstwhile partnership firm. Maintainability of application under Section 245(N) of the Respondents - Held that - The question as to whether capital gains are liable to be paid or not in terms by the transferee Company being a non resident Company, the Respondent herein, would be a matter which would come within the scope of advanced ruling in terms of the said depreciation. Considering the said observations and taking note of the findings of the learned AAR, we find that there is no case made out for interference by this Court under Article 226 of the Constitution of India. The Petitioners were given an opportunity by the learned AAR and the contentions raised were duly considered whilst passing the impugned Orders. We find no reason to interfere in the impugned Orders passed by the learned AAR.

Summary

Issues Involved:
1. Jurisdiction of the AAR.
2. Applicability of Section 47(xiii)(d) and Section 47A(3) of the Income Tax Act, 1961.
3. Determination of capital gains tax liability upon conversion of a partnership firm into a private limited company.
4. Validity of the AAR's ruling on the non-applicability of capital gains tax.

Detailed Analysis:

1. Jurisdiction of the AAR:
The Petitioners contended that the application under Section 245(N) of the Respondents was not maintainable, arguing that the Respondents, not being parties to the transaction, could not seek an advance ruling under clauses (i), (ii), and (iii) of Section 245(N)(a). The AAR observed that the application was maintainable under sub-clause (i) of Section 245N(a), which allows for a determination by the Authority in relation to a transaction undertaken or proposed by a non-resident applicant. The AAR held that the capital gains tax issue had a direct and substantial impact on the non-resident applicant's business, thus falling within the scope of an advance ruling.

2. Applicability of Section 47(xiii)(d) and Section 47A(3) of the Income Tax Act, 1961:
The Petitioners argued that the Respondent-Company violated Section 47(xiii)(d) by prematurely transferring shares, thus nullifying the capital gains tax exemption. Section 47(xiii) exempts transfers of capital assets upon the succession of a firm by a company, provided certain conditions are met, including maintaining a minimum shareholding for five years. The AAR noted that while the first part of clause (d) was satisfied, the second part was not, due to the premature transfer of shares. However, the AAR concluded that the deeming provision under Section 47A(3), which presupposes a transfer, could not be invoked as no profit or gains arose from the conversion.

3. Determination of Capital Gains Tax Liability:
The AAR found that no capital gains accrued or arose at the time of the conversion of the partnership firm into a private limited company. The assets and liabilities were taken at book value, and there was no revaluation or profit realization. The AAR referenced the case of CIT v/s Texspin Engg. & Mfg. Works, which clarified that converting a firm into a company under Part IX of the Companies Act is akin to transmission, not transfer. Consequently, the conversion did not attract capital gains tax.

4. Validity of the AAR's Ruling:
The AAR concluded that the conversion did not result in any capital gains, and thus, the non-compliance with clause (d) of Section 47(xiii) did not trigger capital gains tax liability. The High Court upheld the AAR's findings, noting that the assets' revaluation at the time of conversion was not disputed. The Court also observed that the assessment of the new company and partners post-conversion did not raise any capital gains tax issues. The Petitioners' contention that the exemption ceased due to the violation of clause (d) was rejected, as no capital gains were payable at the time of incorporation.

Conclusion:
The High Court found no reason to interfere with the AAR's ruling, as the Petitioners' contentions were duly considered and addressed. The Petition was rejected, affirming that no capital gains tax was applicable on the conversion of the partnership firm into a private limited company.