Tax Insights
from India Tax & Regulatory Services
Taxability in case of conversion of
firm into company under Part IX of
the Companies Act, 1956
April 24, 2016
In brief
The Gujarat High Court (HC) had held in the taxpayer’s case that conversion of a firm into a
company was not a transfer (even before section 47(xiii) was introduced) and would not be
subject to capital gains tax.
In detail
Facts:
 The taxpayer1, a partnership
firm, was engaged in the
business of real estate
development. In 1980, the
taxpayer had taken land on
lease for a period of 99
years on a monthly rent.
The land and building (a
shopping centre) was
shown as a non-business
asset, and income thereon
was offered as income from
house property. The
property cost was not
recorded in the books of the
taxpayer until financial year
(FY) 1995-96.
limited company under Part
IX of the Companies Act,
1956, and shares of the
converted company were
allotted to the partners of
the erstwhile firm.
 During FY 1995-96, the
taxpayer revalued its land
and building, including the
shopping centre, and the
revaluation difference was
credited to the partners’
capital accounts in their
profit-sharing ratio.
 The Tax Officer (TO) opined
that the shopping centre,
which he contended, had
been introduced into the
firm by way of revaluation of
assets, was nothing but the
income earned by the
taxpayer in the year of
revaluation, and should be
chargeable to tax under
section 28(iv) of the Incometax Act, 1961 (the Act).
Alternatively, the TO
observed that conversion of
firm into company should
have been chargeable to
capital gains tax under
section 45 of the Act.
However, the TO finally
assessed the income on
conversion of the firm under
the head, capital gain.
 Thereafter, on 16 February,
1996, the taxpayer
converted itself into a
 The first appellate
authority, while dismissing
the validity of the claim that
1
it was chargeable under
section 28(iv) of the Act,
upheld the TO’s order
charging capital gains tax
on conversion of firm into
company, stating that the
firm and the company were
two separate entities.
 On further appeal, the
Income-tax Appellate
Tribunal held that,
conversion of firm into
company could not be
brought within the ambit of
section 45(1) of the Act as
there was no consideration
received by the taxpayer. It
also held that section 45(4)
was not applicable, as the
element of distribution of
capital assets in specie by
the firm was missing in case
of conversion of firm into
company.
Issues before the High Court
Did the conversion of firm into
company amount to ‘transfer’
attracting section 45(1) or
section 45(4) of the Act?
[2016] 66 taxmann.com 249 [Gujarat]
www.pwc.in
Tax Insights
Tax authorities’ contentions
Conversion of firm into a
company did not amount to
transfer. Reliance was placed
upon the Bombay HC decision
in Texspin Engineering &
Manufacturing Works3,
wherein it had been held that
transfer of capital assets
involved two important
ingredients: First, a party and
a counter party should exist;
Second, there should be
consideration qua the
transferor. Both these
ingredients were missing in
the present case. Further, in a
similar case, the Supreme
Court, in Well Pack
Packaging4, had agreed with
the Bombay HC’s view3.
Profits or gains arising on
introduction of shopping
centre into the firm in the
form of stock-in-trade and its
subsequent transfer was
chargeable to tax under
section 45(2) of the Act.
 In view of section 45(4) read
with section 45(1) of the Act,
the transaction of transfer of
assets of the firm as a going
concern, would be exigible to
capital gains tax.
 Section 47(xiii) of the Act was
introduced with effect from 1
April, 1999 to provide
exemption on transfer of
capital assets in case of
succession of firm by the
company on fulfilment of
certain conditions. Before this
date, such transactions were
not exempted.
 The partnership firm and the
company were two different
legal entities; upon transfer of
assets by the firm to the
company, capital gains became
payable. Reliance was placed
on the Gujarat HC decision in
case of Artex Manufacturing
Co.2 wherein it had been held
that the principle of mutuality
would not apply to transfer of
business as a going concern,
and would be taxable under
section 45 of the Act.
Taxpayer’s contentions
 To apply section 45 of the Act,
there has to be a transfer
within the meaning of the Act.
2
Artex Manufacturing Co. v. CIT [1981]
131 ITR 559 (Gujarat)
PwC
High Court Ruling
 In Artex Manufacturing Co2,
while all assets and liabilities
of the firm came to be
transferred to the company as
a going concern, it was not a
case of conversion of firm into
company under Part IX of the
Companies Act 1956.
 No facts had been brought on
record to establish that the
properties had been brought
into the books of the taxpayer
as stock-in-trade. On the
contrary, the taxpayer had
always treated the said
shopping centre as a capital
asset.
 The decisions of the Bombay
HC in Texspin Engg. & Mfg
Works3 and of the Gujarat HC
in Well Pack4 squarely applied
to the present case, and hence,
3
CIT v. Taxspin Engg. & Mfg. Works
[2003] 263 ITR 345 (Bombay)
conversion of firm into
company under Part IX was
not taxable under section 45(1)
of the Act.
 Section 45(4) of the Act would
also not apply to the taxpayer
as the primary requirement for
invoking section 45(4) of the
Act was that there had to be a
distribution of capital assets of
the firm, which was totally
missing in the present case.
The takeaways
The Gujarat HC decision has
reaffirmed that conversion of firm
into company does not amount to
transfer under section 2(47) and
is not liable to capital gains tax.
Though the decision pertains to
an assessment year prior to
insertion of clause (xiii) to section
47 of the Act, since it considers
that conversion is not a transfer,
it impliedly confirms nonapplicability of section 47(xiii) of
the Act to a case of conversion
under Part IX of the Companies
Act, 1956.
Let’s talk
For a deeper discussion of how
this issue might affect your
business, please contact:
Tax & Regulatory Services –
Mergers and Acquisitions
Gautam Mehra, Mumbai
+91-22 6689 1154
[email protected]
Hiten Kotak, Mumbai
+91-22 6689 1288
[email protected]
4
CIT v. Well Pack Packaging [2008] 174
Taxman 102(SC)
Page 2
Tax Insights
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