Introduction
In a recent case, titled Atria Wind (Kadambur) (P.) Ltd. v. Deputy Commissioner of Income-tax[i], the Income Tax Appellate Tribunal (‘ITAT’) considered the taxability of long-term capital gains (‘LTCG’) arising from converting a partnership firm into a private limited company. The case involved examining the provisions of s. 47(xiii) of the Income-tax Act, 1961 (‘Act’) concerning the tax treatment of such conversions and the validity of the assessment under s. 153A of the Act when no incriminating evidence was found during the search. The ruling highlights key issues regarding the interpretation of exemptions under the Act and the procedural requirements for conducting a valid assessment in the absence of evidence supporting the addition of income.
Brief Facts
A search under s. 132 of the Act was conducted, resulting in the seizure of records purportedly maintained in the normal course of business. Following the search, a notice under s. 153A of the Act was issued, and the assessee filed its return declaring a loss of Rs. 2,83,86,495/-, as consistent with its original return.
The assessing officer (‘AO’) issued notices under ss. 143(2) and 142(1) of the Act, along with a detailed questionnaire. Based on the seized records, the AO determined the total taxable income at Rs. 189,11,81,757/-, thereby adding Rs.191,95,68,251/- under the head LTCG on the conversion of M/s Perpetual Investments, a partnership firm, into a private limited company.
The AO alleged that the conversion violated the conditions prescribed under s. 47(xiii) of the Act, specifically provisos (a) and (c).
Proviso (a): It was claimed that the assets and liabilities of the firm were not transferred ‘immediately before the succession.’
Proviso (c): The AO alleged that the partners derived indirect benefits other than the allotment of shares, citing the withdrawal of surplus capital before the conversion.
The AO relied on seized documents, including partnership deeds, board resolutions, and financial statements, terming them as incriminating materials.
The assessee contested the addition on the grounds that:
No incriminating materials were found during the search to justify proceedings under s. 153A of the Act.
The conversion complied with all conditions of s. 47(xiii) of the Act, and the alleged violations pertained to transactions unrelated to the ‘immediate’ succession.
The Commissioner of Income Tax (Appeals) ['CIT(A)'] upheld the AO’s findings regarding the LTCG addition while remitting the computation of interest under ss. 234B and 234C of the Act to the AO for reassessment.
The assessee filed an appeal before the ITAT, raising multiple grounds, inter-alia, including procedural lapses in initiating proceedings under s. 153A of the Act, the absence of any incriminating material to warrant reassessment, the erroneous interpretation of provisos (a) and (c) to s. 47(xiii) of the Act and the improper computation of LTCG based on the NAV method.
Held
After considering the submissions of both parties, the ITAT ruled in favour of the assessee, holding that the addition of LTCG was unsustainable.
It found no incriminating material justifying proceedings under s. 153A of the Act. It was observed that the documents seized during the search, which included board resolutions, valuation reports, legal opinions, and financial statements, were ordinary business records maintained by the assessee and could not be classified as incriminating.
The ITAT relied on the Supreme Court’s decision in Abhisar Buildwell P. Ltd.[ii], which held that no additions could be made in the absence of incriminating material in non-abated assessments and observed that in the absence of incriminating material, completed assessments could not be reopened under s. 153A of the Act.
It analysed whether the statutory conditions specified under s. 47(xiii) of the Act were violated and noted that the phrase ‘immediately before the succession,’ as used in proviso (a), implied that the assets and liabilities of the firm at the time of conversion must become those of the company. It observed that in this case, the assessee had filed sufficient evidence, including financial statements and balance sheets as of 26.03.2017 (one day prior to the succession), to demonstrate compliance with this condition.
The ITAT rejected the AO’s claim regarding proviso (c) of s. 47(xiii) of the Act, where it was alleged that the partners withdrew substantial amounts from the firm before the conversion, violating the condition that the partners should receive no consideration or benefit apart from shares. It found that the withdrawals were made much before the date of succession, during the regular course of the firm’s business. These transactions were unrelated to the conversion and could not be construed as consideration for the transfer of assets to the company.
The ITAT also observed that the AO had misinterpreted the provisions of s. 47(xiii) of the Act by attributing significance to events that occurred well before the succession. The language of the section clearly limits its applicability to transactions occurring ‘immediately before the succession.’ Since no evidence was provided to show that the partners received any benefit apart from shares in the company, it concluded that Proviso (c) was not violated.
It emphasized that converting a partnership firm into a company is a tax-neutral event under s. 47(xiii) of the Act, provided the specified conditions are met. The AO’s reliance on unrelated transactions and misinterpretation of statutory provisions rendered the addition unsustainable.
Eventually, the ITAT set aside the CIT(A)’s findings and deleted the addition of Rs. 191,95,68,251 under the head LTCG. It also held that the interest computation under ss. 234B and 234C of the Act were consequential and did not require further adjudication. Thus, it allowed the appeal, providing relief to the assessee.
Our Analysis
The decision reiterates the principle that additions in assessments initiated under s. 153A of the Act must be based on incriminating material unearthed during a search. Routine business records or pre-existing information cannot form the basis of such additions in non-abated assessments. The ITAT reaffirmed the tax-neutral nature of transactions under s. 47(xiii) of the Act, provided the specified conditions are met. It emphasized that the phrase ‘immediately before the succession’ limits the scope of scrutiny to transactions occurring directly in connection with the conversion of a partnership firm into a company. Withdrawals or benefits availed by partners in the ordinary course of business prior to the conversion cannot be deemed a violation of statutory conditions unless they are directly linked to the succession. This decision reiterates the importance of adhering to statutory language while ensuring that additions are substantiated by clear evidence and accurate interpretation of the law.
End Notes
[i] 2024 168 taxmann.com 8 (Banglore- Trib.) [15.10.2024].
[ii] (454 ITR 212).
Authored by Onam Singhal, Chartered Accountant at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.