Taxpublishers.in - Monday Corner Answer to the Quiz for the week (14 Apr 2025)

Share via Whatsapp 453 Views

Back to Monday Corner


Quiz for the week (14 Apr 2025): ABS & Co a partnership firm with 5 equal partners say A, B, C, D and E. The firm got converted in to a company by name ABS (P) Ltd taking over all the assets and liabilities of the firm. The company ABS (P) Ltd issued shares twice the amount of capital to each of the partners, for example it gave 2,00,000 equity shares of Rs.10 each to partner A whose capital in the firm was Rs.10 lakhs. Immediately after the takeover, shareholder A and C sold their entire shares in the company to E. Discuss whether such sale would affect the firm or the company? Will your answer be different if 50% of the consideration is allotted by way of 9% debentures to the partners and there is no sale of shares by shareholders A and C? Best Answer : In the given case ABS & Co is a partnership firm with 5 equal partners A, B, C, D and E. The partnership firm ABS & Co intends to get converted into a private limited company. Hence ABS (P) Ltd takes over all the assets and liabilities of the partnership firm ABS & Co. Section 45 of the Income-tax Act, 1961 states that any profit or gain arising from transfer of a capital asset during a previous year is chargeable to tax under the head ‘Capital Gains’ in the immediately following assessment year if it is not eligible for exemption under sections 54,54B,54D,54EC 54EF,54F, 54G,54GA and 54GB. In the given case, there may be a transfer of capital asset from the partnership firm ABS & Co to ABS (P) Ltd. Hence capital gains may be applicable on such conversion. However, section 47 (xiii) of the Income-tax Act, 1961 states that:- 47. Nothing contained in section 45 shall apply to the following transfers:— (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 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; The condition is partners together hold not less than 50% of the total voting power. (e) the demutualisation or corporatisation of a recognised stock exchange in India is carried out in accordance with a scheme for demutualisation or corporatisation which is approved by the Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992. Therefore, conversion of a partnership firm into a company would not result in long-term capital gain if all the five conditions given above stand satisfied. However, if there is even one violation, section 47A(3) would be attracted. Section 47A(3) says that 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. Thus, when any of the conditions stated above is breached, exemption would be withdrawn and the amount of profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 45 earlier shall be deemed to be the profits and gains chargeable to tax of the company for the previous year in which the requirements of the proviso to clause (xiii) as the case may be, are not complied with. In the given question two scenarios are given. Scenario 1: Immediately after the takeover, shareholders A and C sold their entire shares in the company to E. The partners of the firm together hold not less than 50% of the total voting power in the company and their shareholding continues in such manner for a period of 5 years from the date of succession. Even though, shareholders A and C have sold their shares in the company, it has gone to shareholder E who was a partner previously in the firm. Thus, the aggregate shareholding of all the partners in the company would continue to be more than 50% and therefore the transaction is eligible for exemption under section 47(xiii). The phrase ‘their shareholding continues in such manner for a period of 5 years from the date of succession’ could also be interpreted strictly to say that no change in shareholding pattern of all the partners is permissible when they become shareholders in the company for a period of 5 years from the date of succession. This aspect is still debatable. Scenario 2: In this case, there is no sale of shares by shareholders A and C. However, the consideration for conversion of firm into company was by way of allotment of equity shares and debentures by the company ABS (P) Ltd. Thus, there is a direct violation of the fourth condition specified in section 47(xiii). Only allotment of shares in consideration of conversion of firm into company entitles exemption under section 47(xiii). The moment the debentures are allotted to the partners by the successor company, the benefit of exemption under section 47(xiii) could not be given. Therefore, the entire transaction of the conversion of firm into company is liable for capital gains.

Quiz for the week (14 Apr 2025):

ABS & Co a partnership firm with 5 equal partners say A, B, C, D and E. The firm got converted in to a company by name ABS (P) Ltd taking over all the assets and liabilities of the firm. The company ABS (P) Ltd issued shares twice the amount of capital to each of the partners, for example it gave 2,00,000 equity shares of Rs.10 each to partner A whose capital in the firm was Rs.10 lakhs. Immediately after the takeover, shareholder A and C sold their entire shares in the company to E.

Discuss whether such sale would affect the firm or the company? Will your answer be different if 50% of the consideration is allotted by way of 9% debentures to the partners and there is no sale of shares by shareholders A and C?

Best Answer :

In the given case ABS & Co is a partnership firm with 5 equal partners A, B, C, D and E. The partnership firm ABS & Co intends to get converted into a private limited company. Hence ABS (P) Ltd takes over all the assets and liabilities of the partnership firm ABS & Co.

Section 45 of the Income-tax Act, 1961 states that any profit or gain arising from transfer of a capital asset during a previous year is chargeable to tax under the head ‘Capital Gains’ in the immediately following assessment year if it is not eligible for exemption under sections 54,54B,54D,54EC 54EF,54F, 54G,54GA and 54GB.

In the given case, there may be a transfer of capital asset from the partnership firm ABS & Co to ABS (P) Ltd. Hence capital gains may be applicable on such conversion.

However, section 47 (xiii) of the Income-tax Act, 1961 states that:-

47. Nothing contained in section 45 shall apply to the following transfers:—

(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 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; The condition is partners together hold not less than 50% of the total voting power.

(e) the demutualisation or corporatisation of a recognised stock exchange in India is carried out in accordance with a scheme for demutualisation or corporatisation which is approved by the Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992.

Therefore, conversion of a partnership firm into a company would not result in long-term capital gain if all the five conditions given above stand satisfied. However, if there is even one violation, section 47A(3) would be attracted.

Section 47A(3) says that 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.

Thus, when any of the conditions stated above is breached, exemption would be withdrawn and the amount of profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 45 earlier shall be deemed to be the profits and gains chargeable to tax of the company for the previous year in which the requirements of the proviso to clause (xiii) as the case may be, are not complied with.

In the given question two scenarios are given.

Scenario 1: Immediately after the takeover, shareholders A and C sold their entire shares in the company to E. The partners of the firm together hold not less than 50% of the total voting power in the company and their shareholding continues in such manner for a period of 5 years from the date of succession. Even though, shareholders A and C have sold their shares in the company, it has gone to shareholder E who was a partner previously in the firm. Thus, the aggregate shareholding of all the partners in the company would continue to be more than 50% and therefore the transaction is eligible for exemption under section 47(xiii). The phrase ‘their shareholding continues in such manner for a period of 5 years from the date of succession’ could also be interpreted strictly to say that no change in shareholding pattern of all the partners is permissible when they become shareholders in the company for a period of 5 years from the date of succession. This aspect is still debatable.

Scenario 2: In this case, there is no sale of shares by shareholders A and C. However, the consideration for conversion of firm into company was by way of allotment of equity shares and debentures by the company ABS (P) Ltd. Thus, there is a direct violation of the fourth condition specified in section 47(xiii). Only allotment of shares in consideration of conversion of firm into company entitles exemption under section 47(xiii). The moment the debentures are allotted to the partners by the successor company, the benefit of exemption under section 47(xiii) could not be given. Therefore, the entire transaction of the conversion of firm into company is liable for capital gains.