Income Tax--Current Issues

Practice Update

V.K. Subramani

CONSEQUENCE OF CONVERTING A COMPANY INTO A LLP

Section 47 contains various instances where the transactions though fall in the definition of 'transfer' yet they are not liable to tax. The title to the section says 'Transactions not regarded as transfer'. Clause (xiiib) to section 47 says that conversion of a private company or unlisted public company in to a limited liability partnership (LLP) and the shareholders becoming eligible for getting share of profit in LLP in return for shares held in the erstwhile company as tax neutral. However, this is subject to certain conditions viz (i) all the assets and liabilities of the company immediately before conversion must become assets and liabilities of the LLP; (ii) all the shareholders immediately before conversion must become partners in the LLP and their capital contribution and profit sharing ratio remain in the same proportion as their shareholding in the company on the date of conversion; (iii) shareholders must not receive any consideration or benefit, directly or indirectly, in any form or manner other than by way of share in profit and capital contribution in the LLP; (iv) the aggregate profit sharing ratio of the shareholders of the company in the LLP shall not be less than 50 percent at any time during 5 years from the date of conversion; (v) the total sales or turnover of the company as appearing in any of the 3 previous years preceding the previous year in which conversion takes place does not exceed Rs. 60 lakhs; (vi) the total value of assets as appearing in the books of accounts of the company in any of the 3 previous years preceding the year in which conversion takes place does not exceed Rs. 500 lakhs; and (vii) no amount is paid directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of 3 years from the date of conversion.

Enough planning is possible to overcome the conditions given above by doing necessary acts before resorting to conversion of a company in to LLP. Thus the relief from capital gains tax could be availed. In case, the conditions tagged in the statute are not satisfied, what would happen? Tax consequence would follow. It would be on the shareholders who have exchanged their shares for appropriate portion of share of profits in LLP. The cost of acquisition of shares in the erstwhile company and the proportion of shareholding in the net worth of the LLP on the date of conversion would be compared for computation of capital gain. Valuation of assets as per section 50D read with rule 11UAA would be triggered in such scenario. Whether the company too will be taxed is a tricky question. Since the company ceases to exist on conversion in to LLP and no benefit was obtained by it, there would be no tax consequence in its hands whether the breach of conditions takes place at the time of conversion or at a subsequent date.