By TIOL News Service

BANGALORE, SEPT 18, 2018: THE ISSUE IS - Whether Section 47(xiii)(b) envisages reasonable time limit for allotment of shares in exchange of capital accounts balances of the partners of firm on or before the date of succession of partnership firm by the limited company. YES IS THE VERDICT.

Facts of the case:

The partnership firm M/s Prakash Electric Company comprising of five partners, who were said to be the brothers of the same family, came to be succeeded by the present assessee-company M/s Prakash Electric Company Private Limited, Ambalapady, Udupi. These five partners who became the shareholders of the successor company were however, allotted only 1210 equity shares of Rs.10/- each and remaining shares were allotted to them subsequently in a phased manner. The first allotment came to the extent of 50 equity shares of Rs.10/- each by subscribing to the MoA of the assessee-company. The second allotment was made of 6000 equity shares of Rs.10/- each. The third allotment was made in their favour after a gap of 3½ years to the extent of 4000 equity shares of Rs.10/- each. The final allotment of shares in proportion of the capital account of the partners was made by the company in favour of these erstwhile five partners by issuing 18,50,000 equity shares of Rs.10/- each for a premium of Rs.2.97 per equity share. With these allotments of shares in four phases, the allotment of shares in favour of the erstwhile partners in proportion of their capital account in the firm was completed by the company. Treating such phased allotment of shares as non-compliance with the Proviso clause (b) of Section 47(xiii), the AO imposed the capital gains tax on the partnership firm vide assessment order u/s 143(3) r/w/s 147 for the A.Y 2000-01 and tax liability on the capital gains of Rs.1,33,43,710/- to the extent of Rs.51,37,329/- and with interest u/s 234A & 234B, a total demand of Rs.93,17,550/- was raised against the assessee firm.

On appeal, the CIT(A) upheld the levy of capital gains tax on the partnership firm. On further appeal, the Tribunal held that not the partnership firm, but, the successor company M/s Prakash Electric Company Private Limited would be liable to pay such capital gains tax by virtue of Section 47A(3) inserted by Finance Act, 1998 with effect from April 01, 1999.

High Court that,

++ this Court of the opinion that the provisions of Section 47(xiii)(b) does not envisage the immediate allotment of shares in exchange of capital accounts balances of the partners of the partnership firm on or before the date of succession of business of partnership firm by the limited company. It is true that Clause (b) requires all the partners of the firm immediately before the succession to be allotted the shares in the company in the same proportion in which their capital accounts stood in the books of the firm as on the date of succession but the law does not provide for any specific time limit for such allotment of shares in favour of the erstwhile partners. The process of determining their exact balances in the capital accounts of the partnership firm upon finalization of books of accounts of the partnership firm may take sometime and therefore, the allotment of shares at the face value or at a premium as the company may decide by passing appropriate resolutions may also take time and therefore, the condition imposed in clause (b) has advisedly not prescribed the fixed time limit for allotment of equity shares in favour of the partners of the erstwhile firm, whose business is succeeded by the company. It is not disputed that all the other conditions in the said Proviso to Section 47(xiii) except the issue raised with regard to the point of time for allotment of shares, stood satisfied in the present case, and not only all the five partners were allotted shares in the new company, which succeeded to the business of the partnership firm but their shareholding also never fell below 50% and the minimum holding period of five years was also maintained from the date of succession and no other consideration except in the form of allotment of shares in the company was paid by the company to the erstwhile partners of the partnership firm;

++ the only point that remain for consideration, is about the purported non-compliance with the condition stipulated in clause (b) of Section 47(xiii) and effect thereof on the capital gains tax liability of the erstwhile firm or the successor-company. This Court is of the opinion that the reasonable period of such process of allotment of shares by way of consideration to the partners in proportion to their capital account balance in the partnership firm has to be completed during the relevant previous year itself viz., on or before the end of the previous year in which the succession of business by the company of erstwhile partnership firm takes place. Providing for some period for completing the said process of allotment of shares is also reasonable and necessary because the process of allotment of shares subject to the limits of Authorized Share Capital being increased by the company and issue of the shares by passing necessary Resolutions and allotment of shares by the Board of Directors etc. as required under the provisions of the Companies Act may also be completed within a reasonable period. However, the words 'reasonable period' cannot be stretched to cover a large period like three to four years, as it happened in the present case and the apparent reason assigned by the Assessee in the present case was that the Authorized Share Capital of the company was not increased suitably to make the allotment of these shares to the partners and the consideration for their intended allotment of shares in proportion to their share capital was credited in the 'Shareholders Fund Account' in the Books of Accounts maintained by the Company. This was not a sufficient reason or excuse to delay the process of allotment of shares of the Company in favour of the erstwhile partners to an unreasonably long period of about 3½ years. Had it been a case of other shareholders or outside shareholders also joining the said company and the allotment process of shares could have been legally delayed for 3 years for such other persons also, in a hypothetical case, even such other shareholders would have been deprived of such Dividends from the company, if the reasons assigned by the Company that Authorized Share Capital of the company was not suitably increased was to be taken as a valid excuse, for that purpose. Hence, the Tribunal was justified in holding that the assessee-company was liable to pay such capital gains tax liability instead of the partnership firm and to that extent the AO as well as the CIT(A) fell in error in affixing such liability on the partnership firm.

(See 2018-TIOL-1921-HC-KAR-IT)