Question
XYZ Pvt. Ltd. has converted itself into a Limited Liability Partnership (LLP) on 1.4.2019 and at the time of conversion, all the conditions specified in section 47(xiiib) have been fulfilled. The unabsorbed business loss and depreciation of the company as on the date of conversion were Rs. 40 lakhs and Rs. 27 lakhs respectively. The business profits of the LLP for the previous year 2019-20 were Rs. 75 lakhs. However on 5.9.2020 two partners (who were erstwhile shareholders of XYZ Pvt. Ltd) having in aggregate 51% of the profit sharing in LLP, resigned.
Discuss the tax consequences of the conversion of company into LLP and subsequent resignation of partners.
LET'S FIRST CONSIDER APPLICABLE PROVISIONS
SECTION 47(xiiib) of the Income Tax Act,1961 any transfer of a capital asset or intangible asset by a private company or unlisted public company (hereafter in this clause referred to as the company) to a limited liability partnership or any transfer of a share or shares held in the company by a shareholder as a result of conversion of the company into a limited liability partnership in accordance with the provisions of section 56 or section 57 of the Limited Liability Partnership Act, 2008.
Provided that—
(a) all the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the limited liability partnership;
(b) all the shareholders of the company immediately before the conversion become the partners of the limited liability partnership and their capital contribution and profit sharing ratio in the limited liability partnership are in the same proportion as their shareholding in the company on the date of conversion;
(c) the shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the limited liability partnership;
(d) the aggregate of the profit sharing ratio of the shareholders of the company in the limited liability partnership shall not be less than fifty per cent. at any time during the period of five years from the date of conversion;
(e) the total sales, turnover or gross receipts in business of the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed sixty lakh rupees; and
(f) no amount is paid, either directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of three years from the date of conversion.
Explanation.—For the purposes of this clause, the expressions "private company" and "unlisted public company" shall have the meanings respectively assigned to them in the Limited Liability Partnership Act, 2008.
SECTION 56 OF LLP ACT,2008
A private company may convert into a limited liability partnership in accordance with the provisions of this Chapter and the Third Schedule.
SECTION 57 OF LLP ACT,2008
An unlisted public company may convert into a limited liability partnership in accordance with the provisions of this Chapter and the Fourth Schedule.
SECTION 72A(6A) of LLP Act,2008
Carry Forward and Set Off of Accumulated Losses and Unabsorbed Depreciation in case of 'Reorganization of Business' [Section 72A(6) & (6A)]:
Where there has been reorganisation of business, whereby,—
a. a firm is succeeded by a company fulfilling the conditions laid down in clause (xiii) of section 47, or
b. a proprietary concern is succeeded by a company fulfilling the conditions laid down in clause (xiv) of section 47, or
c. a private company or unlisted company is converted into limited liability partnership
then, the accumulated loss and the unabsorbed depreciation of the predecessor firm or the proprietary concern or a company, as the case may be, shall be deemed to be the loss or allowance for depreciation of the successor company or successor LLP for the purpose of previous year in which business reorganisation was effected.
Business loss will be allowed to be carried forward and set off for fresh 8 years and unabsorbed depreciation can be carried forward and set off indefinitely.
Answer
As per section 72A(6A), the LLP would be able to carry forward and set-off the unabsorbed depreciation and business loss of Rs. 40 lakhs and Rs. 27 lakhs, respectively, of XYZ Pvt. Ltd.
Since at the time of conversion, all the conditions specified in section 47(xiiib) have been fulfilled. Further, the LLP can set off the unabsorbed depreciation and business loss aggregating to Rs. 67 lakhs against its business profits of Rs. 75 lakhs for A.Y.2020-21.
However, if in any subsequent year, the LLP fails to fulfill any of the conditions mentioned in section 47(xiiib), the business loss or unabsorbed depreciation of the company already set off by the LLP would be deemed to be the income chargeable to tax of the LLP for the year in which it fails to fulfill such conditions.
One of the conditions mentioned in section 47(xiiib) is that the erstwhile shareholders of the company continue to be entitled to receive at least 50% of the profits of the LLP for a period of 5 years from the date of conversion.
Since two partners (who were erstwhile shareholders of ABC Pvt. Ltd.) holding in aggregate 51% of the profit-sharing in the LLP have resigned on 5.9.2020, thus the LLP has failed to fulfill this condition.
Therefore, the amount of Rs. 67 lakhs representing unabsorbed depreciation and business losses set-off against profits of the LLP for the A.Y. 2020-21, would deemed to be income of the LLP for the A.Y.2021-22, being the year in which it failed to fulfill the conditions.
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