Mumbai tax tribunal held that the difference between the transfer value and the cost of acquisition shall be NIL when computing capital gains on the transfer of assets and liabilities from a company to a newly incorporated LLP at book value. Consequently, the machinery provision under section 48 of the Income Tax Act, 1961 (‘the Act’), for capital gains computation was considered unworkable.

Brief Background

• The taxpayer was formed by conversion of a private limited company to a LLP.
• The erstwhile company had not conducted any business activities but had acquired tangible and intangible assets and had capital work in progress. Upon conversion, all the assets were transferred and vested in the LLP at book value.
• The erstwhile company and the taxpayer filed ‘Nil return’ and did not claim any exemption u/s 47(xiiib) (Transactions not to be regarded as transfer).
• Order u/s 143(3) of the Act was passed wherein addition was made to total income of the taxpayer of INR. 14.58 crores.
• The tax authorities noted that the total value of assets exceeds INR 5 crores, and therefore one of the conditions of section 47(xiiib) stands violated.
• Thus, section 47A(4) was invoked by tax authorities and thereby the value of assets so vested were regarded as transfer and subjected to capital gain tax.
• The CIT(A) confirmed the additions made by the tax authorities. Aggrieved by the same, the taxpayer approached the Tribunal.
  

Key excerpts from the ruling

• The Tribunal acknowledged that conversion of the company into LLP would be regarded as transfer under section 2(47) and noted that if the conditions specified under section 47(xiiib) are met, an exemption would apply to such transfer from the provisions of capital gains under section 45 of the Act.
• The Tribunal held that since the taxpayer admittedly does not satisfy the cumulative conditions under section 47(xiiib) of the Act, the taxpayer loses its exemption and section 47A(4) does not apply unless exemption under 47(xiiib) was actually claimed.
• The Tribunal placed reliance in the case of ACIT vs. Celerity Power LLP, and opined that all the assets and liability of the erstwhile company got vested in the books of the taxpayer at book value.
• Therefore, the Tribunal found no reason to depart from the view that, since the difference between the transfer value and the cost of acquisition was Nil, therefore, while computing the ‘capital gains’ the machinery provision was unworkable in this case as well.

The ruling, however, does not address the potential applicability of section 50D of the Act, which provides that where the consideration for the transfer of a capital asset is not ascertainable or cannot be determined, the fair market value (FMV) of the asset on the date of transfer shall be deemed the full value of consideration for computing capital gains. In this case, since the assets were transferred at book value rather than FMV, tax authorities could argue that the consideration is unascertainable, thereby invoking section 50D. This could lead to the FMV of the assets being treated as the full value of consideration, subjecting the transfer to capital gains tax.

Additionally, the ruling does not consider the potential applicability of section 56(2)(x) of the Act, which taxes the recipient of property under ‘income from other sources’. If the FMV of the assets transferred to the LLP exceeds the consideration paid by more than INR 50,000, the difference could be taxable in the hands of the LLP. Given that the assets were transferred at book value, tax authorities may argue that section 56(2)(x) applies if the FMV exceeds the book value, potentially leading to tax liability for the LLP.