Honble Chairman
1. This application is filed under section 245Q(1) of the Income-tax Act, 1961 by a non-resident Company which has purchased the entire shareholding of an Indian company. The following question (as recast) arises for consideration:
âOn the facts and in the circumstances of the case, 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?
2. The following is the summary of facts stated in the application.
The applicant is a company incorporated under the laws of Luxembourg, having its registered office in Luxembourg. It is the holding company of its wholly owned subsidiary Anandeya Zinc Oxides Pvt. Ltd. (âAnandeya in short), an Indian company. It purchased 15,49,500 shares of Rs. 10/- each or 99.96% of the shares of M/s Anandeya and the balance 500 shares of Rs. 10/- each were purchased by its nominee, Umicore Finance, Belgium. It entered into a Share Purchase Agreement with the five shareholders holding the entirety of shares in Anandeya on 17.2.2008. Anandeya was also a party to it. Thus, the applicant purchased the entire share holdings in Anandeya and the transfer of shares was completed by 12th August, 2008. Anandeya thus became the wholly owned subsidiary of the applicant.
2.1 Anandeya, the wholly owned subsidiary of the applicant, was incorporated as a private limited company on 13.09.2005 under Part-IX, and more particularly section 565 of the Indian Companies Act, 1956. All the assets and liabilities of the partnership firm-Anandeya Oxides that had been carrying on business w.e.f. 30.11.1993, got vested in Anandeya.
2.2 In 1994, the firm â Anandeya Oxides - set up a plant for the manufacture of high purity white seal zinc oxide of annual capacity of 5000 tonnes per annum. The plant was located in Sancole Industrial Estate close to Marmugoa Port. The plant commenced commercial production in April, 1995 and was converted into 100% export oriented unit in 1996. As at 31st March, 1998 relevant to the A.Y. 1998-99, the assets of the partnership were revalued by a Chartered Accountant of Mumbai for Rs. 5 crores as against the net worth of the business of Rs. 3, 05,896/- shown in the account books of the partnership firm. The excess value of the assets of Rs. 4,96,94,104/- resulting from revaluation was credited to the respective partners accounts. The asset-wise details of the revalued assets are given in the application. It is stated that the revaluation increased the partners capital notionally and it continued to be so till the conversion of firm into company in August, 2005. It is clarified that at the time of registration of the wholly owned subsidiary of applicant company under Part-IX of the Companies Act, 1956 on 13.09.2005, the partners of the erstwhile firm were the same as the share holders of the said company, having share holdings identical with the profit sharing ratio of the 7 partners. The authorized share capital of Anandeya was increased to Rs.2 crores divided into 20 lacs equity shares of Rs. 10/- each. As on the date of purchase of shares by the applicant company on 1st July, 2008, its total issued and paid up capital was Rs.1,55,00,000/- divided into 15,50,000 shares of Rs.10/- each and they were beneficially owned by the five shareholders (who were the erstwhile partners).
2.3 The applicant states that ever since the registration of the partnership firm as Company from 13th September, 2005, the aggregate of the share holding of the erstwhile partners of the firm in the Company has never been less than fifty per cent of the total voting power in the company in that one of the partners, namely, M/s Sankeya Chemicals (P) Ltd. had always more than 50% of the voting power in the company.
2.4 The applicant further states that if the shareholding of the erstwhile partners in the Company â Anandeya had remained intact or did not fall short of 50% of the total voting power of the company for a period of 5 years, the question of paying capital gains tax would never have arisen. However, in view of the transfer of shares before the expiry of 5 years, the condition in clause (d) of proviso to section 47(xiii) has been violated, prima facie giving rise to the liability on the part of the said Company to pay capital gains tax. The parties to the Share Purchase Agreement have entertained a doubt in this regard and stipulated a condition in the Agreement that the Indian company shall pay Rs. 50 lacs to the income-tax department as advance payment towards the possible liability of capital gains arising in the A.Y. 2009-10 and furnish proof of payment to the sellers, namely, the shareholders.
3. It is the contention of the applicant that the registration of the firm as a Company under Part-IX of the Companies Act and the consequent vesting of assets in the Company did not amount to transfer nor any capital gain had arisen within the meaning of section 45 read with section 48 of the Income-tax Act and therefore irrespective of the violation of the condition laid down in clause(d) of the proviso to section 47(xiii), the liability to pay capital gains cannot be fastened on the company, namely, Anandeya.
4. The applicant in its additional statement of facts submitted on 9.10.2009 has clarified that while converting the partnership firm into a company, there was no revaluation of the assets and the assets and liabilities of the firm as also the partners capital and current accounts were taken at their book value in the accounts of the company. The first years audited accounts of the Company for the period 13.9.2005 to 31.3.2006 have been filed before us. It is pointed out that the net worth of the company as on the date of conversion was the same as it was in the hands of the erstwhile firm and there was no increase in the said value.
5. Before proceeding further, we shall refer to the relevant provisions of Part- IX of the Companies Act and the Income-tax Act.
COMPANIES AUTHORISED TO REGISTER UNDER THIS ACT
565. (1) With the exceptions and subject to the provision contained in this section,-
(a) xx xx xx xx xx xx xx xx xx
(b) any company formed after the date aforesaid, whether before or after the commencement of this Act, in pursuance of any Act of Parliament other than this Act or of any other Indian law (including a law in force in a part B State), or of any Act of Parliament of the United Kingdom or Letters Patent in force in India, or being otherwise duly constituted according to law, and consisting of seven or more members; may at any time register under this Act as an unlimited company, or as a company limited by shares, or as a company limited by guarantee; and the registration shall not be invalid by reason only that it has taken place with a view to the companys being wound up:
xx xx xx xx xx xx xx xx xx xx
Certificate of registration of existing companies
574. On compliance with the requirements of this Part with respect to registration, and on payment of such fees, if any, as are payable under Schedule X, the Registrar shall certify under his hand that the company applying for registration is incorporated as a company under this Act, and in the case of a limited company that it is limited and thereupon the company shall be so incorporated.
Vesting of property on registration
575. All property, moveable and immovable (including actionable claims), belonging to or vested in a company at the date of its registration in pursuance of this Part, shall, on such registration, pass to and vest in the company as incorporated under this Act for all the estate and interest of the company therein.
6. Section 575 has been highlighted by the counsel for the applicant to contend that there is a statutory vesting of property on registration. It may be noticed here that the expression âCompany occurring in section 565 and other provisions has been construed to be a group, assembly or association of persons but not a company registered under the Act. A partnership firm is also treated as a Company for the purposes of registration under Part-IX of the Companies Act. This interpretation has been given by the Andhra Pradesh High Court in the case of V.P. Rao v/s Sri Ramanuja Ginning and Rice Factory ((1986) 60 Companies Cases 568 at page 580), having regard to the context and other provisions of Part-IX of the Companies Act.
7. Coming to the provisions of Income-tax Act, sections 45, 47, 47A and 48 need to be referred to.
Section 45(1) is the main charging section.
Capital gains.
45. (1) Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F, 54G and 54H, be chargeable to income-tax under the head âCapital gainsâ , and shall be deemed to be the income of the previous year in which the transfer took place.
Section 45(4) may also be noticed â
The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.
Section 47 lays down that nothing contained in section 45 shall apply to the transfers specified therein. We are concerned with clause (xiii) in that section which reads thus:
Clause (xiii) of Section 47
Nothing contained in section 45 shall apply to the following:
(xiii) any transfer of a capital asset or intangible asset by a firm to a company as a result of succession of the firm by a company in the business carried on by the firm, or any transfer of a capital asset to a company in the course of demutualisation or corporatisation of a recognised stock exchange in India as a result of which an association of persons or body of individuals is succeeded by such company :
Provided that
(a) all the assets and liabilities of the firm [or of the association of persons or body of individuals] relating to the business immediately before the succession become the assets and liabilities of the company;
(b) all the partners of the firm immediately before the succession become the shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of the succession;
(c) the partners of the firm do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of allotment of shares in the company; and
(d) the aggregate of the shareholding in the company of the partners of the firm is not less than fifty per cent of the total voting power in the company and their shareholding continues to be as such for a period of five years from the date of the succession;
Clause (xiii) in the present form was enacted by the Finance Act of 2001 in substitution of the previous clause.
7.1 Section 47(xiii) specifically excludes certain categories of transfer from the purview of capital gains taxation, but it is subject to the fulfillment of the conditions laid down in clauses (a) to (d). For our purpose clause (d) is relevant. All the three conditions i.e. (a) to (c ) are satisfied in the instant case. The first part of clause (d) is also satisfied. However, the requirement in the second part of clause (d) i.e. shareholding of fifty percent or more should continue to be as such for a period of 5 years from the date of succession has not been fulfilled in the instant case by reason of the transfer of shares by the Indian company to the applicant before the expiry of 5 years.
7.2 Then, the effect of transgression of the conditions laid down in the proviso to clause (xiii) is set out in section 47A(3) which reads thus:
47A Withdrawal of exemption in certain cases.
(1) and (2) xx xx xx xx xx xx xx xx xx
(3) Where any of the conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 are not complied with, the amount of profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 45 by virtue of conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 shall be deemed to be the profits and gains chargeable to tax of the successor company for the previous year in which the requirements of the proviso to clause (xiii) or the proviso to clause (xiv), as the case may be, are not complied with. (emphasis supplied)
8. Thus, by virtue of the premature transfer, the transferor company which succeeded the firm has forfeited the protection given under section 47(xiii). It cannot seek the aid of that provision in order to get out of the net of taxation. Was there a transfer of capital assets? Did any profit or gain arise from such transfer? It may be noticed here that sub-section (3) of section 47A under which the transferor company has forfeited its claim to seek exclusion uses the words âthe amount of profits or gains arising from the transfer of such capital assets or intangible assetsâ. It presupposes that there was a transfer of capital asset and that certain profit or gain resulted therefrom which has not been charged to tax earlier. It is this aspect which needs to be dealt with.
9. The reasons for enacting section 47(xiii) together with sub-section (3) of section 47A by the Finance Act of 1998 as seen from Notes on clauses are:
âUnder the existing provision of the Income-tax Act, business reorganizations have definite tax implications. Transfer of assets attracts levy of capital gains tax. Similarly, carry forward of losses and that of unabsorbed depreciation are not available to successor business entities. However, in cases of amalgamation, capital gains tax is not levied and losses and absorbed depreciation are allowed to be carried forward under certain conditions. The Expert Group, in the draft Income-tax Bill, has recognized the need to encourage business reorganizations when they are in consonance with the objective of economic development and are not merely device to secure tax advantage.
The Bill proposes to allow tax benefits in cases of business reorganization where a firm is succeeded by company in the business carried by it and a proprietary concern is succeeded by a company.â
9.1 In the case of CIT v/s Texspin Engg. and Mfg. Works (263 ITR 345), the learned Judges of the Bombay High Court while dealing with Section 45 have given the legislative background for introducing Section 47(xiii) and the basic postulates of this provision in the following words:-
âThis clause was inserted with effect from April 1, 1999. Therefore, we are not concerned with the amendment. However, it provides a clue to the legislative intent. In our opinion, this clause has been introduced with effect from April 1, 1999, in order to encourage more and more firms become limited companies. It also indicates the difference between transfer and transmission. Basically, when a firm is treated as a company under Part IX, it is a case similar to transmission. This is amply made clear by clause (xiii) of section 47, which states that where a firm is succeeded by a company in the business, the transaction shall not be treated as a transfer. Now, this amendment has been made in section 47 in view of the controversy arising on section 45(1)read with section 2(47)(ii).â
Though during the relevant year with which the High Court was concerned, this provision was not there, the scope and objective of the provision was explained thus.
10. Simultaneous with the introduction of cl.(xiii), the legislature has also enacted a Proviso thereto laying down the conditions subject to which the substantive provision in cl.(xiii) should be applied. Not only that, the consequence of violation of those conditions has been specifically laid down in sub-section (3) of Section 47A which was also introduced by the same Finance Act. We are here concerned with a case of violation of one of the conditions contained in cl.(d) of the proviso to Section 47(xiii). Therefore, resort can only be had to sub-section (3) of Section 47A to deny the benefit of exclusion under the substantive part of Section 47(xiii). So, we have to closely look at the language of sub-section (3). What is the consequence provided for by Section 47A(3)? The consequence is that the amount of profits or gains arising from the transfer of such capital asset not charged (emphasis supplied)under Section 45 shall be deemed to be the profits and gains chargeable to tax of the successor company for the previous year in which the non-compliance of the conditions in the proviso to cl.(xiii) had taken place. It must be noted that the deeming in sub-section (3) of Section 47(A) is not absolute. What is deemed to be the profits and gains of the successor company is the amount of profits or gains arising from the transfer of such capital asset not charged earlier. If no profits or gains arose earlier when the conversion of the firm into a company took place or if there was no transfer at all of the capital assets of the firm at that point of time, the deeming provision under Section 47A(3) cannot be invoked to levy the capital gains tax.
11. Assuming that a process of transfer of capital or intangible assets of the firm in favour of the newly registered company is involved, the question arises whether any profit or gain can be said to have resulted on account of the so-called transfer of capital assets of the firm (or the partners thereof) to the company. By virtue of the company receiving the entire assets of the erstwhile firm either on account of consensual or statutory vesting, what is it that the partners of the firm have gained? The only answer could be that they have received the shares in the same proportion in which they had shares in the firm and the shares can be converted into moneys worth. The value of shares of the newly formed company can be arrived at by ascertaining the networth of the company which is the same as that of the firm as per the audited account as on the date of conversion (i.e., 13/9/2005). Even then, did the partners/shareholders derive any profit or gain in the transaction? Can it be said that by getting the shares the value would not be anything more than the partners proprietary interest in the firm, the partners of the firm (assuming that they are transferors) have made any profit or gain in the transaction? These are the crucial questions for which the answer could only be in the negative.
11.1 Shares allotted to the partners of the extinct firm consequential to the registration of the firm as a company did not, in our view, give rise to any profit or gain. By receiving such shares the value of which is nothing more than the value of the sum total of their interest in the firm or the worth of their shareholding in the firm, no gain is made. They have not become richer to any extent. The rise in the share value in course of time does not have a bearing on the intrinsic worth of shares at the point of time when conversion/ succession took place. In a transaction involving the conversion of firm into Company under Part-IX of Companies Act, with all the assets automatically vesting in the newly registered company as per the statutory mandate contained in Section 575, it can hardly be said that the partners have made any gain or received any profit, assuming that there was transfer of capital assets. The worth of the shares allotted to the erstwhile partners was not different from the interest of the partners in the extinct firm when quantified in terms of money. As observed earlier, the partners did not become richer or pocketed any surplus money or moneys worth by becoming shareholders of the newly incorporated Company.
11.2 In the case of Texspin Engg.Mfg. Works (263 ITR 345)the issue was viewed from another angle i.e. from the stand point of Section 48 of the Act in a case of similar conversion of a firm into a company. On the facts similar to the present case, it was held by the Bombay High Court that the very asset transferred or parted with cannot be the consideration for transfer and therefore the market value of that asset cannot enter into computation of capital gain. âFull value of Considerationâ cannot therefore be attributed to the transaction. The legal position was stated thus by S.H. Kapadia J. speaking for the Division Bench of High Court:
âEven assuming for the sake of argument that there is a transfer of a capital asset under section 45(1) because of the definition of the word âtransferâ in section 2(47)(iii), even then we are of the view that the liability to pay capital gains tax would not arise because section 45(1) is required to be read with section 48, which provides for mode of computation. These two sections are required to be read together as the charging section and the computation section constitute one package. Now, under section 48 it is laid down, inter alia, that the income chargeable under the head âCapital gainsâ shall be computed by deducting from the full value of the consideration received or accrued as a result of the transfer, the cost of acquisition of the asset and the expenditure incurred in connection with the transfer. Section 45(4) is mutually exclusive to section 45(1). Section 45(4) categorically states that where there is a transfer by way of distribution of capital assets and where such transfer is due to dissolution or otherwise of the firm, the Assessing Officer was entitled to treat the market value of the asset on the date of the transfer as full value of the consideration received. This latter part of section 45(4) is not there in section 45(1). Therefore, one has to read the expression âfull value of the consideration received/accruingâ under section 48 de hors section 45(4) and if one reads section 48 with section 45(1) de hors section 45(4) then the expression âfull value of considerationâ in section 48 cannot be the market value of the capital asset on the date of transfer. In such a case, we have to read the said expression in the light of the two judgments of the Supreme Court in the case of CIT vs. George Henderson and Co. Ltd. (1967) 66 ITR 622 and in the case of CIT vs. Gillanders Arbuthnot and Co. (1973) 87 ITR 407 in which it has been held that the expression âfull value of the considerationâ does not mean the market value of the asset transferred, but it shall mean the price bargained for by the parties to the transaction. It has been further held that the consideration for the transfer of a capital asset is what the transferor receives in lieu of the assets he parts with, viz., money or moneys worth, and, therefore, the very asset transferred or parted with cannot be the consideration for the transfer and, therefore, the expression âfull value of the considerationâ cannot be construed as having a reference to the market value of the asset transferred and that the said expression only means the full value of the things received by the transferor in exchange for the capital asset transferred by him. In the circumstances, even if we were to proceed on the basis that vesting in the company under Part IX constituted transfer under section 45(1), still the assessee ought to succeed because the firm can be assessed only if the full value of the consideration is received by the firm or if it accrues to the firm. In the present case, the company had allotted shares to the partners of the erstwhile firm, but that was in proportion to the capital of the partners in the erstwhile firm. That allotment of shares had no correlation with the vesting of the properties in the limited company under Part IX of the Act.â
It was further observed :
âIf one reads section 45(1) with section 48, it is clear that the former is a charging section and if that section is applicable, the computation has to be done under section 48, which only refers to deductions from the full value of consideration received or accruing. Section 48 does not empower the Assessing Officer to take the market value as the full value of consideration as in the case of section 45(4). In the circumstances, even if we were to hold that vesting amounts to transfer, the computation is not possible because it has been laid down in the above judgment of the Supreme Court that full consideration cannot be construed to mean the market value of the asset transferred. The Legislature, in its wisdom, has amended only section 45(4) by which the market value of the asset on the date of the transfer is deemed to be the full value of consideration. However, such amendment is not there in section 45(1).â
The proposition that Section 48 has to be read as an integral part of the charging provision in Section 45 has been laid down by the Supreme Court in the case of B.C.Srinivasa Settys case (128 ITR 294). That proposition was reiterated by the Bombay High Court and the High Court proceeded to consider the matter on an interpretation of the expression âfull value of considerationâ.
11.3 The facts of Texspin case are substantially similar to the present case. A firm by name Texspin Engg and Mfg. Works was converted into a Limited Company during the year 1996-97 under Part IX of the Companies Act. The assessing officer took the view that there was a transfer of capital assets by way of dissolution of the firm and therefore the profits or gains from such transfer became chargeable to tax under Section 45(4) of the Act. Further, for the purposes of Section 48 of the Act, the assessing officer computed the capital gains on the difference between the market value and the written-down value of the assets transferred to the Company (vested in the Company). The High Court examined the issue both from the stand point of Section 45(4) and Section 45(1) read with Section 48 of the Act and answered the questions in favour of the assessee and against the Revenue.
11.4 The reasoning of the High Court in the passages extracted above applies in all fours to the present case.
12. On the other aspect, namely, whether there was transfer, the decision in Texspin case is again directly in point. The following observations of the learned Judges may be noted :
âNow, in the present case, it is argued on behalf of the Department before the Tribunal, for the first time, that in this case, on the vesting of the properties of the erstwhile firm in the limited company, there was a transfer of capital assets and, therefore, it was chargeable to income-tax under the head âCapital gainsâ as, on such vesting, there was extinguishment of all right, title and interest in the capital assets qua the firm. We do not find any merit in this argument. In the present case, we are concerned with a partnership firm being treated as a company under the statutory provisions of Part IX of the Companies Act. In such cases, the company succeeds the firm. Generally, in the case of a transfer of a capital asset, two important ingredients are : existence of a party and a counter-party and, secondly, incoming consideration qua the transferor. In our view, when a firm is treated as a company, the said two conditions are not attracted. There is no conveyance of the property executable in favour of the limited company. It is no doubt true that all properties of the firm vest in the limited company on the firm being treated as a company under Part IX of the Companies Act, but that vesting is not consequent or incidental to a transfer. It is a statutory vesting of properties in the company as the firm is treated as a limited company. On the vesting of all the properties statutorily in the company, the cloak given to the firm is replaced by a different cloak and the same firm is now treated as a company, after a given date. In the circumstances, in our view, there is no transfer of a capital asset as contemplated by section 45(1) of the Act.â
12.1 Though these observations were made in the context of Section 45(4), the ratio of the decision would equally apply to the present case. However, the question whether vesting by operation of law would be transfer has not been decided in that case. True, the decision in Texspin was rendered without taking resort to Section 47(xiii) and the Proviso thereto. But, the basic reasoning underlying the said judgment still holds good. 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 âstand alone provision.
13. In the light of the above discussion, it is ruled that 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. No final opinion is expressed in regard to the question whether on the registration of company under Part IX of the Companies Act, there was âtransfer of capital assets.
Accordingly, ruling is given and pronounced on this the 12th day of March, 2010.