Conversion of partnership firm

This query is : Resolved

Querist : Anonymous

Querist : Anonymous (Querist)

28 August 2012 If a firm converts into a company, the partners are alloted shares in the company. What will be the cost of such shares? Which section provides for the same?

Ahamed

Ahamed (Expert)
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28 August 2012 Transfer of – (a) a capital asset or intangible asset by a predecessor firm to its
successor company; or (b) a capital asset to successor company in course of
demutualisation/corporatisation of predecessor recognized stock exchange in India
(being an Association of Persons or Body of Individuals) [S. 47(xiii)]
(a) All the assets and liabilities of the firm/AOP/BOI relating to their
business immediately before the succession become the assets and
liabilities of the company;
(b) In case of firm, all its partner become shareholders of the company in the
same proportion in which their capital accounts stood in the books of the
firm on the date of the succession;
(c) In case of firm, the partners receive consideration only by way of
allotment of shares in company.
(d) In case of firm, the partners shareholding in the company in aggregate is
50% or more of its total voting power and continue to be as such for 5
years from the date of succession; and
(e) The demutualisation or corporatisation of a recognized stock exchange in
India is carried out in accordance with a scheme for demutualisation or
corporatisation, which is approved by the SEBI.

I hope that it would clear your doubt,

Querist : Anonymous

Querist : Anonymous (Querist)

29 August 2012 No, my doubt is not resolved. The partners will receive shares in the company pursuant to converion. When they will sell these shares, what cost will they take? If its their capital acc balance on the date of conversion, from which section does it come from? please revert.

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Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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20 July 2024 When a partnership firm converts into a company and the partners receive shares in the company in exchange for their partnership interests, the cost of these shares for the partners is crucial for tax purposes. Here’s how it generally works under Indian tax laws:

### Cost of Shares Received in Exchange for Partnership Interests:

1. **Section 45(2) of the Income Tax Act, 1961**:
- **Cost of Acquisition**: According to Section 45(2), when a capital asset (such as partnership interest) is transferred by a firm to a company in the course of conversion, the cost of acquisition of shares allotted in the company to the partners shall be deemed to be the cost of acquisition of the capital asset to the firm.
- In simpler terms, the cost of the shares received by the partners will be the same as their capital account balance in the partnership firm immediately before the conversion.

2. **Calculation of Capital Account Balance**:
- The capital account balance of each partner in the partnership firm is determined as per the terms of the partnership deed. It typically includes the initial capital contributed by each partner and adjustments for profits, losses, drawings, etc., as per the partnership agreement.

### Tax Implications When Shares are Sold:

1. **Cost of Acquisition for Capital Gains**:
- When the partners eventually sell these shares received in exchange for their partnership interests, the cost of acquisition for calculating capital gains tax will be their capital account balance in the partnership firm as on the date of conversion.
- This is because of the specific provisions under Section 45(2) of the Income Tax Act, which deems the cost of acquisition of the shares to be the same as the cost of the capital asset (partnership interest).

### Procedure and Documentation:

- During the conversion process from a partnership firm to a company, proper documentation should be maintained to establish the capital account balances of the partners.
- The conversion process typically involves preparing a conversion agreement, allotment of shares, updating statutory registers, and filing necessary forms with the Registrar of Companies (ROC).

### Conclusion:

Under Section 45(2) of the Income Tax Act, the cost of shares received by partners in a company upon conversion from a partnership firm is deemed to be their capital account balance in the partnership firm. This ensures consistency and clarity in determining the cost of acquisition for tax purposes when these shares are eventually sold. It’s advisable to consult with a tax advisor or chartered accountant for specific advice tailored to your situation and to ensure compliance with all applicable tax laws and regulations.