Business Reorganizations and Restructuring including conversion of private limited company or a partnership into a LLP and tax issues

Presentation by

Yogesh Thar June 14, 2015

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Direct Tax Convention-Rajkot

Background .....“Purpose/ Intention”

- Sale of Entire Company – Sale of shares/ Amalgamation

- Sale of company/Division – Slump Sale/Demerger/Slump Exchange

Tax implication different for buyer and seller

Indirect tax/ Stamp duty implications required to be analyzed before finalizing the mode of restructuring

Time period for carrying out arrangement (Private Sale/Court Scheme)

Clear transfer of title in case of court approved scheme. Ease of transfer of existing contracts, etc

Now in Court scheme- Tax Department NOC required – General Circular 1/20142

Modes

Amalgamation/ Merger

Demerger

Slump Sale

Buy- Back

Itemised/ Outright

Sale

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Modes of restructuring

Amalgamation/ Merger

Amalgamation of a company by way of a court approved scheme Tax neutral on fulfilment on conditions in section 2(1B) Court Approved Process, hence time consuming

Demerger Hive off of an undertaking by way of court approved scheme Tax neutral on fulfilment on conditions in section 2(19AA) Court Approved Process, hence time consuming

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Various Modes of Restructuring (1/2)

Slump Sale Transfer of undertaking as a whole for lump sum consideration

Itemised Sale Sale of individual assets for specific consideration

Outright Sale Transfer of shares to the buyer

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Various Modes of Restructuring (2/2)

Tax Issues arising out of restructuring

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Section 80-IA(12A) - deduction not available to the Amalgamated/Resulting Company on transfer of undertaking claiming deduction u/s 80-IA

Section 80-IA(12) provided for deduction u/s 80-IA available to amalgamated/resulting company for period upto 1 April 2007

Memorandum states demerger should be tax neutral and not attract any additional liability to tax and the benefits should continue to be available upon transfer

Circulars* issued by CBDT clarifying that the transferee company would not be eligible for the deduction

Benefit of deduction u/s 80-IA is qua ‘undertaking’ and not qua assessee

Whether on transfer other than amalgamation/demerger- transferee eligible to avail 80-IA(12A)

* Circular no 3 of 2008 and Circular No 10 of 2014

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Deduction u/s 80-IA- on Amalgamation /demerger

Section 80-IA(12A) provide for claim of deduction in case of amalgamation / demerger of the undertaking

Circulars also state the tax holiday for residual period would not be available for transferee company on amalgamation/ demerger

The terms “Amalgamation/ demerger” used in aforesaid section and circulars would mean “amalgamation” as defined u/s 2(IB) of the Act and “demerger” as defined u/s 2(19AA)

CBDT Circular No.10 of 2014 further clarifies that transfer not by way of amalgamation or demerger, the transferee shall be eligible for the deduction for the unexpired period u/s 80-IA(12A)”

Decision of the Bombay High Court in the case of CIT v Sonata Software Ltd* held that tax holiday benefit attaches to the ‘undertaking’ and not to the taxpayer entity which houses the undertaking. Transfer of undertaking by way slump sale or as a going concern entitled to deduction u/s 10A

* [2012] 21 taxmann.com 238

Deduction u/s 80-IA – on transfer other than amalgamation/ demerger

Section 80-IC provides for deduction in respect of profits and gains derived by undertaking engaged in manufacture of article or things

Section 80-IC does not contain any corresponding amendment in sub-section (7) of section 80-IC restricting deduction u/s 80-IC to amalgamated /resulting company

Amalgamation/ demerger of the eligible undertaking – deduction allowed u/s 80-IC in the hands of transferee as per the provisions of sub-section (12) of section 80-IA

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Whether similar provision u/s 80-IC

Sections 2(1B) of the Act :

“Amalgamation” in relation to companies means merger of one or more companies with another company or the merger of two or more companies to form one company….

Section 2(19AA) of the Act :

“demerger”, in relation to companies, means the transfer …by a demerged company of its one or more undertakings to any resulting company

The term company is defined u/s 2(17) of the Act as under :

(i) any Indian company, or

(ii) any body corporate incorporated by or under the laws of a country outside India, or …”

Section 2(17)- Does not include partnership firm

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Whether partnership firm- party to amalgamation

Section 582 of Companies Act, 1956 - the expression “unregistered company” -

“(b) save as aforesaid, shall include any partnership, association or .....at the time when the petition for winding up the partnership, association or company, as the case may be, is presented before the Court”

Bombay High Court in M/s Kirtidas Kakiads Diamonds Exports P Ltd (In re) [2009] held that a partnership firm being unregistered company u/s 582(b) of the Companies Act, 1956

Corresponding section under Companies Act, 2013 (‘Co’s Act, 2013’)- Section 375* contains similar provisions

* To be enforced

The principle to be tested under the Co’s Act, 2013

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Whether partnership firm- party to amalgamation

Capital Gains There is transfer of assets

no consideration flowing from Resulting Company to Demerged Company – Allotment of shares directly to the shareholders of Demerged Company – Not regarded as payment of consideration

CIT V. Master Raghuveer Trust (Kar.) (151 ITR 368)

Hence, No Capital Gains Tax

Implications u/s 56(2): On receipt of shares (not being shares of public company)

Hands of Demerged Company

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Tax Implications- Non Compliant demerger

Capital Gains: There is no Transfer – No exchange, relinquishment or extinguishment of

any rights – No Capital Gains Tax

Dividend u/s 2(22): Demerged company does not receive any consideration – Hence, reserves

get depleted. But there is no distribution or payment made by the Company – Hence, not covered u/s 2(22)

Allotment of shares by the Resulting Company to shareholders of Demerged Company – Not a distribution of accumulated profits or assets to shareholders – Hence, not covered u/s 2(22)

Even if Reduction of Share Capital of Demerged Company – Cannot be covered u/s 2(22) as there would be no accumulated profits or reduction in capital of Resulting company, which would allot shares

Implications 56(2)(viib) On issue of shares

Hands of Shareholders- Demerged Co

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Tax Implications- Non Compliant demerger

Demerger of Investment undertaking – compliant with section 2(19AA)

To qualify as an “undertaking” as per Explanation 1 to section 2(19AA) Undertaking includes :

- even a part of an undertaking ; or - division ; or - a business activity, which in itself constitutes “business activity”

Business activity does not necessarily mean income chargeable under business income Shares held as investments or stock-in-trade, such acquisition of shares would be regarded as

the business activity of the company

Investment activity to qualify as an undertaking u/s 2(19AA) The division to be separately identified i.e. the assets, liabilities, employees, etc. attributable to

the Division can be identified

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Shareholders

Company Resulting Company

Holding Company

100%

Issue shares

Demerger of undertakingUnit A

Whether issue of shares by the Holding Company of the resulting Company would qualify as tax compliant demerger u/s 2(19AA)

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Tax Compliant demerger

Definition of Resulting Company As per section 2(41A) of the Act :

“resulting company” means one or more companies (including a wholly owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger and, the resulting company in consideration of such transfer of undertaking, issues shares to the shareholders of the demerged company and …;”

Section 2(41A) defines a resulting company as one or more companies which perform two obligations: - receiving the undertaking and - issuing shares

As per Section 2(19AA) the resulting has to be the recipient of an undertaking from the demerged company

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Section 56(2) implications- on buy-back

in a buy-back, seller

(shareholders)

sells the shares

and company buys it back

hence, it involves an act of “receiving” shares

by the company

itself

It makes no

difference even if shares are its

own and are to be cancelled

soon thereafter

Section 56 (2)(viia) would apply and

hence, the

company would be required

to be valued at

fair market value

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Conversion of a Private Company into an LLP – Procedural aspects

Section 56 and Third Schedule to LLP Act to be complied with

Partners of LLP should consists of all shareholders of converted private company and no one else

Application for conversion to be made in Form 18 along with

•No objection Certificate from tax authorities/ Other requisite approvals•Prescribed forms for application and declarations•List of Creditors with their consent

Effect of Registration of LLP• all tangible (movable and immovable) property as well as intangible property vested in the company, all assets, interests, rights, privileges, liabilities, obligations relating to the firm and the whole of the undertaking of the firm shall be transferred to and shall vest in the LLP without further assurance, act or deed; and

• the company shall be deemed to be dissolved

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Conversion of a Private Company into an LLP – Tax Implications

Section 47(xiiib) specifically provides that conversion of a company into an LLP in accordance with section 56 or 57 of LLP Act would not be regarded as transfer, if following conditions are satisfied

The total turnover/ gross receipts in business do not exceed Rs 60 lakhs in 3 years prior to the previous year- Turnover means chargeable under the head “Profits and Gains from Business and Profession” – Circular No.

1/2011

All shareholders immediately before conversion become partners in LLP The shareholders do not receive any consideration or benefit other than share in profit of LLP The aggregate PSR of the erstwhile shareholders should not be less than 50%v of profits at LLP

for 5 years from date of conversion No provision under the Act specifically providing that conversion does not amount to transfer All assets and liabilities of company immediately prior to conversion become assets and liabilities

of LLP No amount is paid, directly or indirectly to any partner out of accumulated profit of company on

date of conversion for 3 years from date of conversion 19

Conversion of a Private Company into an LLP – Tax Implications Section 47A(4) – If any conditions not complied with , capital gains on such transfer not charged

earlier will be taxable in the hands of successor LLP in the previous year when such non- compliance takes place

Even if the conditions of section 47(xiiib) are not complied with Assets and liabilities of the company vest in the LLP

- Statutory Vesting of assets and liabilities is not transfer - Texspin Engg. & Mfg. Works; - ACIT Vs. Unity Care & Health Service

If capital gains to be taxed, what should be the value of consideration?- In the absence of consideration no capital gains can arise- Market value of asset transferred cannot be deemed to be consideration if transfer at book value

and book value should be considered

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Conversion of a Private Company into an LLP – Tax Implications If conditions of section 47(xiiib) are violated in the year of conversion itself, whether section 47A(4) would be

attracted?- If conditions of section 47(xiiib) violated in the year of conversion itself, it would mean that the assessee

has not got 47(xiiib) benefit, and section 47(xiiib) would not be applicable to the assessee- Since section 47(xiiib) not applicable, section 47A(4) cannot be invoked- Aravali Polymers LLP v. JCIT (Kol)

Whether LLP can claim 80-IA/ similar deduction available to the private company?- Deduction attaches to the undertaking and not the owner thereof- However, LLP will have to pay AMT; - MAT credit of company would not be allowed to the LLP

Carry forward and set off of losses available to the company by the LLP - If conditions of section 47(xiiib) complied, section 72A permits carry forward and set off of losses to LLP ;- LLPA provides all “assets , interest, rights, privileges ” available with the company would vest in the LLP,

therefore unabsorbed losses as well should vest in the LLP and be available for set off and carry forward ;- Akin to succession/inheritance

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Conversion of a firm into an LLP – Procedural aspectsSection 55 and Second Schedule to LLP Act to be complied with

Partners of LLP should consists of all partners of converted partnership firm and no one else

•Admission or retirement of partners can be done before or after conversion

Application for conversion to be made in Form 17 along with• Statement of consent of partners of the firm• Statement of Assets and Liabilities of the firm• acknowledgement copy of latest income tax return• Approval from an regulatory body/ authority, if any, required• List of Creditors along with their consent• Other prescribed formsEffect of Registration of LLP• all tangible (movable and immovable) property as well as intangible property vested in the firm, all

assets, interests, rights, privileges, liabilities, obligations relating to the firm and the whole of the undertaking of the firm shall be transferred to and shall vest in the LLP without further assurance, act or deed; and

• the firm shall be deemed to be dissolved• All pending proceedings, conviction, ruling, order or judgments, existing agreements, contracts, etc. of

the firm to apply to LLP

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Conversion of a firm into an LLP – Tax Implications No provision under the Act specifically providing that conversion does not amount to transfer However, Explanatory memorandum to Finance Bill, 2009 provides an LLP and a general

partnership are treated as equivalent under the Act - the conversion will have no tax implications• if the rights and obligations of the partners remain the same after conversion and • if there is no transfer of any asset or liability after conversion

- if there is a violation of the conditions, the provisions of section 45 shall apply- It can still be argued that conversion does not result in ‘transfer’ within the meaning of Sec-

2(47) nor there is any specific provision U/s 45 to treat such a conversion as transfer - Vesting of assets and liabilities not a transfer - CIT vs Texspin Engineering and

Manufacturing Works (263 ITR 345) [Bom] Provisions pertaining presumption taxation u/s. 44AD which can be availed by partnership

firm are not applicable to LLP

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Changes in Capital Structure Allotment at differential pricing to existing shareholders and to new investors :

- Section 56(2)- Section 2(24)(iv)

Reduction of Capital- whether ‘transfer’ ?- Kartikey Sarabhaoi – 228 ITR 163 (SC)- G Narasimhan 236 ITR 327 (SC)

Effects of rights renunciation Expenses on raising capital

- Share Capital- Debt• Convertible• Non-Convertible

Expenses on Capital Reduction

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Miscellaneous

Whether carry forward and set off of unabsorbed book depreciation/ book losses will be available for adjustment against book profits of the amalgamated company?- VST Tillers & Tractors Ltd v. CIT (2009 TIOL 26) (Bang. ITAT)

Whether the MAT credit of the amalgamating company will be available to the amalgamated company - MAT credit available to “assessee”- “Assessee” would include successor, as successor would be taxed on behalf of assessee- MAT credit is a relief provision, should be construed liberally- SKOL breweries Ltd. V. ACIT (2008 TIOL 741) (Mum. ITAT)

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MAT Issues- Business reorganization

Meaning of “shares and “shareholders” in section 2(1B) and section 2(19AA)- In both cases, shares needs to be issued to existing shareholders- The shares by transferee company needs not be only ‘equity’ can be ‘preference too’

Applicability of section 56(2)(vii)- “Receipt” of unlisted shares- Amalgamation/Demerger at fair value – valuation report obtained - PNB Finance Ltd v. CIT (337 ITR 75) – Business sold as a whole, cannot be split into parts

Whether Goodwill arising on amalgamation is eligible for depreciation?- Section 32(1)(ii) defines intangible assets as “know how, patents, copyrights, trademarks,

licenses, franchises or any other business or commercial rights of similar nature”.- Goodwill on amalgamation – falls within “any other business or commercial rights of similar

nature”.- Smifs Securities (348 ITR 302)

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Miscellaneous

Whether accounts are required to be redrawn if appointed date does not coincide with year end? If the accounts for the FY end are approved and adopted in AGM before the Effective Date –

cannot be reopened or revised following the Circular No. 12/77 [1/1/77-CL-V and 2/331/75-CL-II], dated 21/11/77 ;

Effect of the scheme to be given in the next FY end Accounts, disclosing results from the Appointed Date till the next FY end ;

If the accounts for the FY end are not approved – effect of the scheme to be given from the Appointed Date till the FY end following the ratio laid down by SC in Marshall Sons & Co. (India) Ltd. V. ITO (223 ITR 809)

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Miscellaneous

How would Return of Income be filed where appointed date does not coincide with year end?- Upon Scheme becoming effective, Transferee Company is vested with all income, assets, etc.

of the Transferor from the Appointed Date [Marshall Sons & Co. India Ltd. v/s ITO (223 ITR 809) – SC]

- Therefore, Transferee Company to file return of income in respect of income of Transferor Company for period starting from the Appointed Date

- The assessment of such return will be in the hands of the Transferee Company

Whether profits for period between appointed date and effective date to be assessed in hands of transferor or transferee? - As transferor assessee could not retain profits in its own hands after sale agreement, profit

post date of agreement cannot be assessed in hands of assessee, and ought to be assessed in hands of transferee (Dalmia Cement Limited v. CIT (237 ITR 617))

- Marshall Sons & Co. India Ltd. v/s ITO (223 ITR 809)

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Miscellaneous

Whether issue of bonds / debentures alongwith shares conforms with the definition of “Amalgamation”? - Gautam Sarabhai Trust (173 ITR 216) (Guj)

Section 72A applies inter alia to a company owning “industrial undertaking”? - Defined in clause (aa) of sub-section (7)- Scope cannot be expanded to include service industry - Apollo Hospitals Enterprises Ltd. (300 ITR 167) (Mad)

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Miscellaneous

Accumulated business loss and unabsorbed depreciation of the Amalgamating Company deemed to be loss/ depreciation allowance of the Amalgamated Company - Is the period exhausted by the Amalgamating Company to be considered for computing the

period available for claim by the Amalgamated Company ?- Supreme Industries Ltd. (17 SOT 476)(Mum)(2007)

Whether Section 72A will override Section 79?- Section 79 – Non obstante clause – overriding other provisions of the Act.- Proviso of Section 79 – shall not apply in a situation where private company / company in

which public are not substantially interested merges into another company- Section 72A specifically deals with amalgamations.- Objective of enacting Section 72A

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Miscellaneous

Whether Amalgamation could be considered a design to avoid capital gains tax ? - Wood Polymer Limited and Bengal Hotels Pvt. Ltd. (109 ITR 177) (Guj) - Star Television Entertainment Ltd. (321 ITR 1) (AAR)

Tax savings effect of Demerger scheme-- Vodafone Essar Gujarat V DIT (24 taxmann.com 323) (Guj)

Scheme sanctioned by BIFR under SICA ?- Whether SICA to have overriding effect with respect to Income Tax Act ? - JK Corporation Ltd. (331 ITR 303) (Cal)

Whether tenancy rights get automatically transferred on amalgamation to the transferee ?- General Radio And Appliances Co. Ltd And Others v. M.A Khader (Decd) By Legal

Representatives (60 Compcas 1013)

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Miscellaneous

Whether individual values can be assigned to assets in a slump sale- Identification of price attributable to individual items (plant, machinery and dead stock) which

are sold as part of slump sale, may not entitle a transaction to be qualified as slump sale - CIT v. Artex Manufacturing Co.(227 ITR 260) (SC)

- Contrary view in CIT V. Electric Control Gear (227 ITR 278) - Separate value is assigned to land/building under the relevant stamp duty legislation, the slump

sale will not be adversely affected - Explanation 2 to S. 2(42C)

Can Assets be transferred in slump sale without transfer of liabilities? - No liability was transferred to the buyer - transfer of undertaking would not be regarded as a

slump sale -Mahindra Sintered Products Ltd. v. DCIT, (95 ITD 380)(Mum.) - Sale of chemical unit was not regarded as slump sale, because there was transfer of assets

without transfer of liabilities -Weikfield Products Co. (I) (P.) Ltd. v. DCIT, [71 TTJ 518 (Pune)

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Slump Sale- Issues

Whether Negative Net Worth to be ignored for computing Capital Gains?

• Summit Securities ltd. (Mum-Trib) (SB) – Negative figure of Net Worth not to be ignored for computing CG in case of a slump sale

• Zuari Industries Ltd (105 ITD 569) (Mum) – Reversed after the ruling laid down by SB as aforesaid

Whether a sale of an undertaking considered as a Slump Sale when certain assets and liabilities pertaining to such undertaking are retained?

• Rohan Software Pvt. Ltd. v. ITO (117 TTJ 490) (Mum)- All business assets were transferred except for certain assets such as building, motor cars an assets and liabilities relating to income-tax matters

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Slump Sale- Issues

Where assets are transferred for a consideration of another asset other than money – Considered as exchange and not sale- CIT v. R.R. Ramkrishna Pillai (66 ITR 725) (SC)- CIT v. Motors & General Stores (P.) Ltd. (66 ITR 692) (SC)

CIT v. Bharat Bijlee Limited (Bom) (364 ITR 581)- Transfer of a business undertaking as a going concern against issuance of bonds/ preference shares was not a sale, but an exchange

SREI Infrastructure Finance Ltd. v. Income-tax Settlement Commission (207 Taxman 74) - transfer of business in exchange of another asset is sale as an element of monetary consideration involved

Slump sale v. Slump Exchange

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Can tax liability of Transferor Company be assessed in the hand of Transferee Company?

Amalgamation

amalgamating company is not in existence

Business of amalgamating co succeeded by Amalgamated Co.

Assessment made in the hands of Amalgamated Co.

Demerger/Slump sale

only an undertaking is transferred

Not complete succession, but ‘partial’ succession

assessment continued in the hands of Demerged Co

CIT v. K.H. Chambers (55 ITR 674) - ‘succession’ under section 170 involves change of ownership, that is, the transferor goes out and the transferee comes in; it connotes that the whole business is transferred

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Whether company is eligible to gift shares to another company

Applicability of section 56(2)(viia)- On reduction of share capital

Mirror image companies- demerger/ amalgamation- Fair value not required

Income u/s 2(24)(iv)- on issue of shares to a ‘person who has substantial interest’ in case of demerger

“Loss” arising on slump sale – whether eligible to be set-off

Other issues - business reorganization

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