The Mumbai bench of the Income-tax Appellate Tribunal (ITAT) has delivered a ruling favoring the taxpayer (Amartara Pvt. Ltd v DCIT, ITA No. 6114/Mum/2016) (Ruling) which could impact corporate restructurings significantly and increase the popularity of LLP as a preferred form of entity for business. The ITAT has held that for the purposes of computing the capital gains arising to a partner from capital contribution in the form of immovable property, consideration would be the ‘value at which the firm/LLP records such capital contribution in its books of account’ (Book Value) and not the ‘value of such property for the purposes of payment of stamp duty’ (Stamp Duty Value).
The issue for consideration before the ITAT was in relation to interpretation of two deeming fictions contained in section 45(3) and section 50C of the Income-tax Act, 1961 (IT Act).
- Deeming fiction qua the nature of transaction
Section 45(3) of the IT Act provides that (i) when a capital asset is transferred to a partnership firm/LLP as a capital contribution, the profits or gains arising from the transfer of capital asset shall be chargeable to tax as income of the financial year in which such transfer takes place and (ii) the Book Value shall be deemed to be the full value of the consideration received or accruing as a result of the transfer. Thus, section 45(3) performs the dual tasks, of bringing the capital contribution by a partner within the tax net, and also deeming the Book Value as the ‘full value of consideration’ for computing capital gains in the hands of the contributing partner.
- Deeming fiction qua the nature of asset
Section 50C of the IT Act provides that Thus, section 50C provides only a deeming fiction of what value would be adopted as the consideration for computing capital gains in case of transfer of land or building or both.
In the instant case, the taxpayer, an Indian company had entered into an LLP agreement followed by a supplementary agreement, contributing its immovable property (Immovable Property) in the LLP as its capital contribution. While the LLP recorded this capital contribution of Immovable Property at INR 5.60 crores based on a valuation report, the stamp duty authorities determined the fair market value of the Immovable Property for the purposes of payment of stamp duty at INR 9.41 crores. Thus, the Book Value and the Stamp Duty Value of the Immovable Property was INR 5.60 crores and INR 9.41 crores respectively.
For computing the capital gains on this capital contribution, the taxpayer adopted the Book Value (i.e. INR 5.60 crores) as consideration on the premise that section 45(3), which follows the Book Value driven capital gains computation, is a special provision for computation of capital gains on transfer of capital assets from a partner to the partnership firm/LLP. On the other hand, the assessing officer (AO) as well as the first appellate authority (CIT(A)) adopted the Stamp Duty Value (i.e. INR 9.41 crores) as consideration and made addition to the taxable income of the taxpayer on the premise that section 50C, which follows the Stamp Duty Value driven capital gains computation, is more specific. To arrive at this conclusion, the AO and CIT(A) placed reliance on the decision of ITAT, Lucknow bench in the case of Carlton Hotel Pvt Ltd vs ACIT (122 TTJ 515) (Luck) in which it was held that where a capital contribution by a partner to a partnership firm/LLP is sought to be registered and stamp duty is paid, the Stamp Duty Value would be adopted as the consideration for computing capital gains.
Being aggrieved by this, the taxpayer filed an appeal before the ITAT.
The ITAT, distinguished the Carlton ruling (supra) on facts, and decided the issue in favour of the taxpayer. The ITAT held that section 45(3) is a specific provision for the following reasons:
- section 45(3) specifically deals with cases of capital contribution by a partner to a partnership firm/LLP;
- section 45(3) provides for computation mechanism of capital gains and also provides for the value to be adopted for the purpose of determination of full value of consideration.
Thus, the ITAT held that where there is a transfer of an asset as contribution by a partner to the partnership firm/LLP – section 45(3) should apply to the contribution of immovable property by the taxpayer. Consequently, the addition made by the AO and CIT(A) were deleted and the issue was decided in favour of the taxpayer.
Further, the ITAT relied on the judgment of the Supreme Court in CIT v Moon Mills Limited (1966) 59 ITR 574, wherein it was observed that one deeming fiction cannot be extended by importing another deeming fiction. Accordingly, the ITAT, held that another deeming fiction provided by way of section 50C cannot be extended to compute deemed full value of consideration as a result of transfer of capital asset under section 45(3) of the IT Act.
This is a welcome decision by the ITAT (the second appellate authority under the IT Act) as it seeks to put to rest the controversy regarding the manner of computation of capital gains in relation to capital contribution in the form of immovable property by a partner to a partnership firm/LLP – i.e. whether to adopt the Book Value as consideration or to adopt the Stamp Duty Value as consideration. In doing so, the ITAT has given precedence to special provision qua the transaction (i.e. section 45(3)) and not to the special provision qua the asset (i.e. section 50C).
Further, it is interesting to note that the Authority for Advance Rulings (AAR), had, in the case of Canoro Resources Limited, a Canadian partnership firm, held that for computing capital gains in the hands of a partner in relation to capital contribution, the transfer pricing provisions being special provisions would override the provisions of section 45(3), thus upholding the requirement to contribute the assets at fair value. This case has not been discussed in the instant Ruling. Also, it is worth noting that established principles of statutory interpretation that the law which is later in time should prevail was not argued by the department in the Ruling.
Though the Ruling provides respite to partners in a partnership firm/LLP, one would need to test the applicability of section 56 of the IT Act in the hands of the recipient partnership firm/LLP in case the Book Value of a partner’s capital contribution falls short of the Stamp Duty Value (in case of immovable property) or fair market value (in case of other assets). Moreover, it needs to be borne in mind that any structuring regarding contribution of assets at book value by partner would need to pass the smell test under general anti avoidance rules, which have come in force from 1 April 2017.
Further, while this Ruling dealt with a period when section 50CA – which contains a fair market value based deeming fiction for computing capital gains in relation to transfer of unquoted shares - was not in the IT Act, one would hope that the principle upheld by this Ruling i.e. precedence to special provision qua the transaction (i.e. section 45(3)) would be followed even in relation to capital contribution in the form of unquoted shares.
The principles enunciated in this Ruling would give a fillip to use of a LLP as a preferred form of business entity.