Capital Gains Tax upon Conversion of Company into LLP

Facts of the case:

The applicant is a U.K. based company having its subsidiary in India.
The Indian company proposed to be converted into LLP as per the provisions of LLP Act, 2008.
Upon conversion, the equity shares held by the applicant in the company would be converted into partnership interest in LLP.
Due to cumulative fulfillment of exemption provisions u/s 47(xiiib) of the LLP Act had not been satisfied, AAR held that transaction shall be treated as ‘transfer’ liable for capital gain tax under the provisions of section 45 of the Act.
In the case, AAR concerned that the capital gains arising in the hand of the shareholder and not in the hand of the company.

Applicant’s Contention:

The applicant contended that the value of partnership interest is same as cost of acquisition of shares in the company. Hence as a result the question of capital gains does not arises.
The applicant contended that the conversion of company into LLP has been done as per the provisions of the LLP Act, 2008 and as the transfer of shares on conversion is exempted from tax u/s 47 (xiiib) of the Act, the shareholders shall not be not be liable to capital gains tax.

AAR Observation and Ruling:

On conversion of company into LLP all tangible and intangible property were transferred to and vested in the LLP. On such vesting not only share capital of Indian entity but also shareholders interest in the shares of Indian entity got extinguished which is covered under definition of ‘transfer’.
Full value of consideration of shares foregone will be equivalent to value of partnership interest in LLP. If value of partnership interest can’t be ascertained or determined for any reasons, then the fair market value of the same has to be taken.
The AAR held that the statement ‘value of partnership interest is same as cost of acquisition (CAO) of shares in the company’, is not correct as this is against the provisions of the Act which defines the term COA.
As a result, AAR held that the computation mechanism u/s 45 read with section 48 of the Act is workable and capable of being implemented.
Thus, the mode of computation of capital gains tax is as per the provisions prescribed u/s 48 of the act. The full value of consideration received/accrued to each shareholder, as a result of relinquishment of shares, will be the value of the capital in newly formed LLP for the purpose of computation of capital gains u/s 48 of the Act.

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