In the case of ISC Specialty Chemicals LLP[1] (‘the Assessee’) for the assessment year 2018-19. It deals extensively with the conversion of a private limited company into a limited liability partnership (LLP) and the taxation implications under the Income Tax Act, 1961, particularly focusing on capital gains tax provisions.
Facts of the Case
ISC Specialty Chemicals LLP was incorporated on June 13, 2017, on conversion of ISC Specialty Chemical Pvt. Ltd. under Section 56 of the LLP Act, 2008. The company had acquired tangible and intangible assets funded by director loans and share capital but had not started business operations before conversion.
Upon conversion, all assets, liabilities, rights, and the whole undertaking of the company vested in the LLP at book value with shareholders receiving LLP interests proportionally.
The Assessee filed a nil income tax return for the year, but the Assessing Officer (AO) added INR 14,58,72,150 as income under Section 45 (capital gains tax) on the ground that conditions under Section 47(xiiib) were violated due to asset value exceeding Rs. 5 crores.
The Assessee argued no exemption was claimed under Section 47(xiiib), conversion did not result in capital gains, and since asset and liability values matched at book value, there was no taxable gain.
Assessee argued as under:
- No exemption was claimed under Section 47(xiiib). Hence Section 47A(4) is not applicable.
- Conversion does not amount to transfer triggering capital gains since no consideration was received other than interest in LLP.
- Assets and liabilities were transferred at book value; hence, there is no capital gain.
- Assessee relied on following precedents in support of its claim that conversion is not a taxable event without profit arising,
- Clerity Power LLP[2]
- This Tribunal decision clarified that conversion of a private limited company or an unlisted public company into an LLP constitutes a “transfer” within the meaning of Section 2(47) of the Income Tax Act. However, such transfer is exempt from capital gains tax under Section 47(xiiib) if certain conditions are satisfied cumulatively. These conditions include limits on turnover, proportionate distribution of profits and shares, no payment to partners out of accumulated profits, and asset valuation thresholds (below Rs. 5 crores).
- The ruling emphasized the legislative intent behind Section 47(xiiib) inserted by the Finance Act, 2010, to exempt small companies converting to LLPs from capital gains tax to reduce regulatory burdens. The Tribunal rejected arguments that conversion does not amount to transfer under the Income Tax Act. It concluded that conversion is a transfer but exempt when all statutory conditions under Section 47(xiiib) are met.
- Umicore Finance Luxembourg[3]
- This decision addressed the conversion of a partnership firm into a private limited company. The Court upheld an Authority for Advance Ruling that such conversion did not amount to a “transfer” attracting capital gains tax since no profit or gain arose at the time of conversion.
- The Court distinguished this from other transactions and emphasized the absence of taxable gains in succession-type conversions. This ruling supports the proposition that there is no capital gains liability where no actual gain arises upon conversion, even if legal “transfer” occurs.
- Texspin Engineering Manufacturing Works[4]
- This case dealt with the computation of capital gains and clarified the proper understanding of “full value of consideration” under Section 48 of the Income Tax Act. The Court held that the “full value of consideration” is what the transferor actually receives for the asset, not the market value.
- The Court emphasized the need to interpret charging (Section 45) and computation (Section 48) provisions together, highlighting that capital gains tax is computed on the price bargained for, not on an imputed market value. This precedent is pivotal for valuation arguments in conversion cases where asset transfer occurs at book value.
- Madurai Mills Co. Ltd[5]
- In this 1973 Supreme Court judgment, the Court held that the distribution of assets by a liquidator on voluntary winding-up of a company does not constitute sale, transfer, or exchange for tax purposes under the Income Tax Act.
- The Court reasoned that where the statutory language excludes certain transactions from sale or transfer characterization, such distributions retain their character, and no capital gains arise from the mere act of liquidation or asset distribution. This case is cited analogously to argue that certain involuntary or statutory transfers do not attract capital gains tax.
- George Henderson and Co. Ltd[6]
- The Supreme Court decisions clarified the meaning of “full value of consideration” for the purpose of capital gains computation. The Court held that this term means the actual price bargained and paid in the transaction, not the market value or any notional value.
- The rulings establish that in transactions where assets are transferred at book value or cost, the value for tax computation is the book value itself, and any difference with market value is irrelevant. This principle underpins the reasoning that conversions at book value result in no taxable capital gains if cost equals book value.
Arguments by the Revenue
- Conversion is a transfer as per Income Tax Act.
- Conditions under Section 47(xiiib) were violated (asset value > Rs. 5 crores), thus exemption is lost.
- Section 47A(4) should apply to tax gains since conditions were breached.
- The entire asset value should be considered capital gains.
Tribunal’s Findings and Reasoning
- On Whether Conversion is a Transfer
- Conversion of a company into an LLP is a “transfer” under the Income Tax Act as per Section 2(47) definition.
- However, whether it attracts capital gains depends on fulfillment of conditions under Section 47(xiiib).
- The Tribunal distinguishes the term “transfer” as used in the Income Tax Act from that in the Transfer of Property Act, noting the wider interpretation under the Income Tax Act.
- Relevant precedents including ACIT vs. Clerity Power LLP (Tribunal Mumbai) state the conversion is a transfer but exempt if conditions are met.
- On Applicability of Section 47A(4)
- Section 47A(4) applies only to withdraw exemption already claimed.
- Since the assessee never claimed exemption, invoking Section 47A(4) in the year of conversion is incorrect.
- Failure to meet Section 47(xiiib) conditions means exemption under Section 47(xiiib) cannot be claimed but does not automatically invoke Section 47A(4).
- On Violation of Asset Limit Condition
- Assessee failed to meet Rs. 5 crores asset limit condition under Section 47(xiiib).
- Consequently, exemption under Section 47(xiiib) is lost.
- Nonetheless, capital gains must be computed correctly under Section 45 read with Section 48.
- On Computation of Capital Gains
- Despite loss of exemption, capital gains computation must follow Sections 45 and 48 together.
- The “full value of consideration” is the consideration actually received—here, the book value at which assets & liabilities transferred.
- Since no separate payment was made and book value equaled the cost of acquisition, the resultant capital gains amount was NIL.
- The cost of acquisition for the LLP is deemed to be the same as for the predecessor company under Section 49(1)(iii).
- On Successor LLP Liability
- Any capital gains, if incurred, would not arise in the hands of the LLP.
- The successor LLP is liable to be assessed on income after succession date if it continues the business; however, here no income was carried forward post-conversion.
This judgment provides a nuanced analysis of conversion transactions, balancing the literal statutory conditions and underlying tax principles, along with interpretation of predecessor-successor assessments and the limited scope of withdrawal provisions.
It is a key precedent for taxpayers and practitioners dealing with conversion of companies into LLPs under the Income Tax Act in India with emphasis on sections 45, 47(xiiib), 47A(4), 48, 49, and 170. The clarified position makes clear the importance of meeting prescribed conditions for exemption and correct capital gains computation methodology.
For detailed discussion, please feel free to contact devadhaantu@devadhaantu.in
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[1] ISC Speciality Chemicals LLP [I.T.A No. 457/Mum/2025]
[2] ACIT vs. Clerity Power LLP (2018) 100 taxman.com 129 (ITAT Mumbai)
[3] CIT v. Umicore Finance Luxmeborg [2016] 76 taxmann.com 32/244 Taxman 43 (Bom.)
[4] CIT v. Texspin Engineering Manufacturing Works [2003] 263 ITR 345 (BOM)
[5] CIT vs. Madurai Mills Co. Ltd. [1973] 89 ITR 45 (SC)
[6] CIT v. George Henderson and Co. Ltd. [1967] 66 ITR 622 (SC)