Recently, the Mumbai Bench of the Income Tax Appellate Tribunal (Tribunal) ruled that conversion of a company into an LLP (limited liability partnership) firm would be construed as a transfer and thus, be chargeable to tax on the pretext that specific tax neutrality conditions provided in the Income Tax Act, 1961 (IT Act), are not complied with. Though the tribunal went on to compute the capital gains tax as Nil, it would be worthwhile to discuss the background of this issue to understand the impact of this judgement.
The LLP Act provides an enabling provision for conversion of a company into an LLP. Since LLPs offer a more flexible mode of carrying on business, along with the fact that they are not liable to a dividend distribution tax as applicable to companies, conversion was considered actively by existing businesses operating as companies. The Finance Act, 2010, introduced Section 47(xiiib) under the IT Act, which provided for compliance with certain conditions to enable tax-neutral conversion of a company into an LLP. These key conditions revolve around the turnover size and asset size prior to conversion, as also the continued majority ownership of existing shareholders and preservation of the existing reserves.
For companies which were not in compliance with the above conditions, a position on non-chargeability of tax was considered, placing reliance on an earlier judgement of the Bombay High Court (HC). The Bombay HC had ruled under the provisions of Part IX of the Companies Act that conversion of a firm into a company does not involve the existence of a party and a counterparty to constitute a transfer and further there is no consideration involved.
via Tax uncertainty continues on LLP conversions | Business Standard Column
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