By CA Surekha
Judicial, Practical, and Strategic Guidance for Professionals)
Judicial Backbone of Section 47(xiiib): Tax-Neutral Conversion – Conditional, Not Absolute
Section 47(xiiib) of the Income-tax Act, 1961 provides tax neutrality for conversion of a Private Limited Company (Pvt Ltd) into a Limited Liability Partnership (LLP). However, this neutrality is conditional. Violation of even one statutory condition attracts retrospective taxation under Section 47A(4), deeming the conversion as a “transfer” for capital gains purposes.
Courts have repeatedly affirmed this conditional immunity principle:
| Case | Key Judicial Ratio | Practical Takeaway |
|---|---|---|
| ACIT v. Texspin Engineering & Mfg. Works (2003) 263 ITR 345 (Bom.) | Conversion into LLP (then firm) not “transfer” if shareholders become partners in same proportion and no consideration received. | Established conceptual foundation of “no transfer” principle. |
| Celerity Power LLP v. ACIT (2018) 169 ITD 664 (Mum.) | Conversion invalid where revaluation surplus was credited before conversion — condition of “no other benefit to shareholders” violated. | No revaluation, bonus issue, or profit distribution prior to conversion. |
| Umicore Finance Luxembourg (2021) (ITA No. 6334/Mum/2018) | “Transfer” definition to be read in substance; violation of conditions even indirectly nullifies exemption. | Strict adherence to all Section 47(xiiib) clauses mandatory. |
| M/s Kethan & Co. LLP (2023) (ITAT Bangalore) | Subsequent partner withdrawal tantamount to capital distribution; triggered Section 47A(4). | Withdrawal or capital reduction within 3 years prohibited. |
Statutory Conditions and Time-Lock Analysis
| Condition under Section 47(xiiib) | Requirement | Effect of Violation / Judicial View |
|---|---|---|
| (a) All assets and liabilities of the company become assets and liabilities of the LLP. | Transfer must be absolute and mirror the balance sheet. | Partial transfer voids exemption. |
| (b) All shareholders become partners of the LLP and their profit-sharing ratio mirrors the shareholding ratio. | Ownership proportion continuity test. | If any shareholder excluded or ratio altered → taxable transfer. |
| (c) Shareholders receive no consideration other than partnership interest. | No cash, loan, or asset transfer permissible. | Even indirect payment (e.g., loan account credit) = breach. |
| (d) Profit-sharing ratio = shareholding ratio at conversion. | Safeguards continuity of ownership. | Change of ratio later acceptable only after 3 years. |
| (e) Total asset book value ≤ ₹5 crore in any of the 3 preceding years. | Absolute upper cap for tax neutrality. | If exceeded, conversion becomes taxable instantly. |
| (f) No security interest in assets subsisting at conversion. | Ensures clean title transfer. | Any pending charge or loan security invalidates exemption. |
| (g) No distribution of accumulated profits for 3 years post-conversion. | Lock-in for profit withdrawals. | Violation reopens capital gains retrospectively. |
Lock-in Period:
All post-conversion restrictions under clauses (d) and (g) are effective for 3 years from the date of conversion. (Earlier drafts mentioned seven years; the Finance Act 2016 clarified it to three years.)
Asset Threshold and Revaluation Caution
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The ₹ 5 crore asset book-value limit is absolute. Even a marginal breach disqualifies tax neutrality.
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Revaluation or fair-value adjustments immediately before conversion inflate book values, triggering capital gains.
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Celerity Power LLP (supra) underscores that revaluation entries intended to step up partner capital are treated as “benefit derived,” invalidating exemption.
💡 Do Not:
Revalue land, building, or investments before conversion.
Issue bonus shares or declare reserves as dividend pre-conversion.
Distribute accumulated profits within 3 years post-conversion.
Cascading Tax Impact if Conditions Breached
| Event Trigger | Section Invoked | Tax Consequence | Example / Risk |
|---|---|---|---|
| Violation of any condition | 47A(4) | Conversion treated as transfer on original date | LTCG computed as if sold to LLP at FMV |
| Accumulated profits distributed within 3 years | 47A(4) + 45 | Gains taxable in LLP/partners’ hands | Reopens scrutiny up to 8 years |
| Book value > ₹ 5 crore | 45 + 50C | Entire appreciation taxable in Co. hands | No rollover or exemption allowed |
| Partner withdraws capital or profit within lock-in | 47A(4) | Retrospective withdrawal of exemption | Demands & penalties possible under 271(1)(c) |
Post-Conversion Tax & Compliance Landscape
| Parameter | Private Ltd (Before) | LLP (After) | Tax Planning Note |
|---|---|---|---|
| Dividend distribution | DDT abolished but taxed in shareholders’ hands (Sec 115BBDA). | Profit withdrawal taxed in partners’ slab (Sec 10(2A) exemption for profit share). | LLP allows DDT-free withdrawals. |
| Minimum Alternate Tax (MAT) | Applicable. | Not applicable. | MAT credit forfeited on conversion. |
| Remuneration to directors/partners | Limited deductibility (Sec 40(b) not applicable). | Governed by Sec 40(b). | Align deed clauses to claim remuneration. |
| Audit & ROC compliance | Under Companies Act 2013. | LLP Act 2008 + IT Act Sec 44AB. | Statutory audit threshold: ₹ 40 lakh turnover / ₹ 25 lakh contribution. |
| Capital infusion or FDI | Allowed under FEMA (FDI policy for Co.). | FDI in LLP allowed only in 100% automatic sectors. | Check FDI eligibility before conversion. |
Strategies for Tax-Efficient Withdrawal or Realisation
Objective: Extract liquidity from the LLP or original Pvt Ltd with minimal tax incidence.
| Method | Legal Basis | Effective Tax Cost | Cautions / Compliance |
|---|---|---|---|
| Partner remuneration | Sec 40(b) + Sec 10(2A) | Deductible in LLP, taxable to partner | Must be per LLP Deed and “wholly for business.” |
| Interest on capital | Sec 40(b) + Sec 10(2A) | Deductible up to 12% | Market-linked rate only. |
| Capital repayment (after 3 years) | Sec 47A lock-in over | Nil if capital corresponds to contribution | Maintain capital accounts & records. |
| Loan repayment from LLP to partner | Normal repayment | Tax-neutral if genuine | Avoid disguised profit withdrawals. |
| Asset sale by LLP | Sec 45 read with 47(xiiib) | Capital gains taxable in LLP | Plan holding period; use indexation. |
✅ Pro Tip:
The most efficient post-conversion withdrawal plan is a combination of partner remuneration and interest, within the LLP Act limits, until the 3-year lock-in expires.
Emerging Risks (2024–25 Onwards)
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AI-based MCA–CBDT Cross-Verification: detection of disguised revaluations or pre-conversion distributions.
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CPC–ITR scrutiny for MAT credit lapses and profit withdrawals during lock-in.
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FEMA non-compliance exposure for LLPs with foreign shareholders converting without FDI approval.
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Section 115TD (exit tax) can apply if LLP later converts into a trust or relocates abroad.
Practical Checklist — Do’s & Don’ts
| ✅ Do’s | ❌ Don’ts |
|---|---|
| Verify book value ≤ ₹ 5 crore in each of 3 preceding years. | Do not revalue assets pre-conversion. |
| Ensure all shareholders become partners in same ratio. | Do not alter ratio or remove partner within 3 years. |
| Obtain CA certificate validating Sec 47(xiiib) conditions. | Avoid declaring dividend, bonus shares, or reserves adjustment before conversion. |
| Draft LLP Deed carefully (capital, remuneration, interest clauses). | Do not ignore charge satisfaction on MCA before filing Form 18. |
| Maintain audit trail of assets and capital accounts. | Do not distribute accumulated profits within 3 years. |
Strategic Insight — When Conversion Makes Sense
| Suitable Scenario | Avoid Conversion If... |
|---|---|
| Small, asset-light, closely held company with profits to be withdrawn flexibly. | You expect asset revaluation, foreign investment, or listing plans. |
| Family-run business aiming to reduce compliance & DDT burden. | High tangible assets (> ₹ 5 crore) or secured loans exist. |
| Professional firm structure (consultancy, design, legal, etc.). | Entity holds immovable property under long-term development project. |
Concluding Guidance
Section 47(xiiib) is not merely a tax relief but a conditional safe harbor demanding corporate, accounting, and compliance discipline.
Professionals must advise clients not merely on conversion mechanics but on post-conversion conduct for at least 3 years.
The key principle:
“Tax-neutrality under Section 47(xiiib) is not a one-time benefit — it is a continuing compliance covenant.”
