Taxable, but with no Tax Liability

That’s the decision of the Mumbai Tax Tribunal on tax effect of conversion of a company to a Limited Liability Partnership where the transfer of assets was effected at Book Values, but without conforming to the conditions laid down under the Tax law [Section 47(xiiib)] for an ‘exempted transfer’.  The decision was rendered in the case of Celerity Power LLP -Formerly Celerity Power Private Ltd.

The Tax payer sought to contend that its conversion into an LLP should be uneventful for Tax purposes as there was no ‘Transfer’ as per Tax law, but only ‘vesting’ of its assets, liabilities, et al to the LLP. The Tax Tribunal was not impressed with the argument and held that the conversion did result in a Taxable event. However, the Tribunal accepted the argument of the Taxpayer that there are no ‘gains’ accruing to it from the transaction as the transfer happened at Book Values.

Who’s Liable?

The Tax Tribunal agreed in-principle to the Tax payer’s argument that the liability to tax, if at all, rests on the ‘transferor’ or the erstwhile company, but held that since the LLP was the successor to the company, it could be rightfully assessed  as the Company was ‘not to be found’. The decision on the point was however academic, given that no taxable gains were held to arise from the transaction.

No carry forward of Tax losses

The Taxpayer had no luck on this one, with the Tribunal ruling that the Tax losses of the company cannot be claimed as ‘carry forward’ by the successor LLP as the conditions prescribed under the Tax law were admittedly not satisfied.

Tax Breaks u/s. 80-IA to continue

The Tax Tribunal agreed with the Tax payer that Tax breaks available to the erstwhile company u/s. 80IA would continue to be enjoyed by the LLP for the remaining period for which the company was entitled.

Our comment

Conversions to LLP are attractive from a Tax standpoint on account of the fact that LLPs enjoy single-level Taxation benefit with the partners completely exempt – as against dual taxation in the corporate format.

However, the conditions under the Tax law for the LLP conversion to be exempt from capital gains taxation are rather restrictive. The ruling in this case sets the stage on how such conversions would be viewed from a legal standpoint, given that most such transactions would not qualify for exemption.

In our view, the base argument advanced on behalf of the Taxpayer – that there was no Taxable event – required a more detailed and sympathetic consideration given that it takes ‘two to transfer’ – while in conversion, its the same entity operating in a different legal format. Further, the argument that was accepted – that there was ‘no gain’ has a potential pitfall for a Taxpayer – what if Transfer Pricing provisions were also to be invoked..