2025 (6) TMI 1998 - AT - Income Tax

Addition u/s. 68 r.w.s. 115BBE - unexplained credit - conversion of a private company into a limited liability partnership (LLP) and the treatment of accumulated profits - assessee firm upon conversion to LLP has transferred the share capital and reserves and surplus to the partners accounts - AO held that as the assessee has violated the conditions of Section 47(xiiib)(f) of the Act where it cannot take any amount directly or indirectly to any partner out of accumulated profit for a period of 3 years from the date of conversion - CIT(A) deleted addition HELD THAT - Section 47 pertain only to transfer for the purpose of Section 45 which is for determining the capital gain on profits or gains arising from such transfer of a capital asset. In the present case in hand though the ld. AO has specifically mentioned that the assessee has violated the conditions u/s. 47(xiiib)(f) of the Act he has proceeded to make addition u/s. 68 of the Act which is specifically for credits in the books of the assessee for which the assessee offers no explanation as to the nature and source to the satisfaction of the ld. AO. In the present case in hand it is not the issue of credits found in the assessee s books of accounts rather it is the allegation that the assessee firm upon conversion to LLP has transferred the share capital and reserves and surplus to the partners accounts which is quite evident that the nature and source of the credit is not unexplained. AO has also erred in making addition in the hands of the assessee when even assuming that there was transfer it is the credit in the partners account and not in the assessee s account. We are not justified in upholding the addition made by the ld. AO u/s. 68 of the Act were none of the ingredients of the said provision is attracted in present case in hand. The violation of condition prescribed u/s. 47(xiiib)(f) of the Act is only with regard to the computation of capital gain u/s. 45 on certain transfers of a capital asset. AO has failed to give a finding on the issue of whether the alleged transfer would be liable for capital gain and that to the same has to be in the hands of the transferor. As this issue is not before us and it is also not the case of neither the revenue nor the assessee we are refraining from giving our view on the same. The limited scope of the present appeal is pertaining to Section 68 addition which we have given a categorical finding that the same is not attracted in the present case in hand on the abovementioned observation. We therefore find no infirmity in the order of ld. CIT(A) in deleting the impugned addition. Assessee appeal allowed.

Summary

The core legal question considered in this appeal is whether the addition of Rs. 2,71,66,500/- made by the Assessing Officer (AO) under Section 68 read with Section 115BBE of the Income Tax Act, 1961 ("the Act") as unexplained credit is justified, particularly in light of the provisions of Section 47(xiiib)(f) of the Act concerning the conversion of a private company into a limited liability partnership (LLP) and the treatment of accumulated profits.

Another closely related issue is whether the conditions prescribed under Section 47(xiiib)(f) of the Act, which prohibit any payment, directly or indirectly, to partners out of accumulated profits for a period of three years from the date of conversion, have been violated by the assessee, thereby justifying the addition.

Additionally, the Tribunal considered whether the invocation of Section 68 was appropriate in the present facts, and if the addition should have been made in the hands of the assessee firm or the partners, given the nature of the transaction post conversion.

Issue-wise detailed analysis:

1. Applicability of Section 47(xiiib)(f) of the Income Tax Act:

The relevant legal framework is Section 47(xiiib) of the Act, which specifies that certain transfers of capital assets or shares by a private company to an LLP upon conversion shall not be regarded as transfer for capital gains tax purposes, subject to conditions (a) to (f). Clause (f) specifically prohibits any payment, directly or indirectly, to any partner out of the accumulated profits standing in the accounts of the company on the date of conversion for a period of three years from the date of conversion.

The AO observed that the assessee firm, upon conversion from NICAF Private Limited to NICALF LLP, credited the entire reserves and surplus amounting to Rs. 2,71,66,498/- to the capital accounts of the partners. The AO held that this amounted to a violation of Section 47(xiiib)(f) as it constituted payment out of accumulated profits within the prohibited period, allegedly to evade Dividend Distribution Tax (DDT).

The Tribunal noted that Section 47 deals exclusively with the non-recognition of transfer for capital gains computation under Section 45. The prohibition in clause (f) is a condition for the tax neutrality of conversion, preventing distribution of accumulated profits to partners for three years post conversion.

The Tribunal found that the AO did not conclusively establish that any payment, direct or indirect, was made to the partners out of accumulated profits within the three-year period. The first appellate authority (CIT(A)) had examined documentary evidence, including bank statements of partners, and concluded no such payment was made.

Hence, the Tribunal accepted the CIT(A)'s finding that the condition under Section 47(xiiib)(f) was not violated. The transfer of capital asset by the private limited company to LLP was tax neutral and complied with the provisos.

2. Validity of addition under Section 68 read with Section 115BBE:

Section 68 deals with unexplained credits in the books of the assessee, where the assessee fails to satisfactorily explain the nature and source of such credits. Section 115BBE applies a special rate of tax on income declared or assessed under certain sections including Section 68.

The AO treated the reserves and surplus credited to partners' capital accounts as unexplained credit in the hands of the assessee firm, making an addition of Rs. 2,71,66,498/- under Section 68 read with Section 115BBE.

The Tribunal observed that the AO's invocation of Section 68 was misplaced. The issue was not unexplained credit in the books of the assessee firm, but a transfer of capital and reserves to partners' accounts post conversion. The nature and source of the credit were not unexplained but reflected in the financials of the LLP.

Furthermore, the Tribunal pointed out that even assuming the transfer was irregular, the addition under Section 68 could not be made in the hands of the assessee firm because the credit was in the partners' accounts, not the firm's books. Section 68 additions require unexplained credits in the assessee's own accounts, which was not the case here.

The Tribunal also noted that the AO failed to address whether the alleged transfer would attract capital gains tax under Section 45, which is the relevant provision for transfer of capital assets, and that the violation of Section 47(xiiib)(f) pertains only to capital gains computation and not to unexplained credits under Section 68.

3. Treatment of competing arguments:

The revenue argued that the transfer of accumulated profits to partners' capital accounts was a device to evade DDT and violated Section 47(xiiib)(f), justifying addition under Section 68. The revenue relied on a coordinate bench decision supporting this view.

The assessee contended that no payment was made to partners from accumulated profits within three years, supported by documentary evidence including bank statements. The assessee further argued that Section 68 was wrongly invoked as there was no unexplained credit in its books and any tax implication, if at all, would arise in the hands of the partners.

The Tribunal found the assessee's contentions supported by evidence more convincing and held that the AO's addition under Section 68 was not sustainable. The Tribunal refrained from expressing any opinion on capital gains tax implications under Section 45 as it was not the subject matter before it.

Significant holdings include the following:

"Section 47 pertains only to transfer for the purpose of Section 45 which is for determining the capital gain on profits or gains arising from such transfer of a capital asset."

"The violation of condition prescribed u/s. 47(xiiib)(f) of the Act is only with regard to the computation of capital gain u/s. 45 on certain transfers of a capital asset."

"We are not justified in upholding the addition made by the ld. AO u/s. 68 of the Act, where none of the ingredients of the said provision is attracted in the present case in hand."

"The limited scope of the present appeal is pertaining to Section 68 addition which we have given a categorical finding that the same is not attracted in the present case."

The Tribunal ultimately dismissed the revenue's appeal and upheld the deletion of the addition by the CIT(A), allowing the assessee's cross objections.