Does the merger of an LLP into a company facilitate the “Ease of Doing Business”?

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  • By Taxmann
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  • Last Updated on 17 November, 2022

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Recently, the Chennai Bench of the National Company Law Tribunal (NCLT) has allowed the amalgamation of an LLP into a company. The NCLT held that there does not appear any express legal bar on allowing the merger of an Indian LLP with an Indian Company. Furthermore, the legislative intent behind enacting the Limited Liability Partnership Act, 2008 (LLP Act, 2008) and the Companies Act, 2013 was to facilitate the ease of doing business and create a desirable business atmosphere for companies and LLPs. In the ruling, the NCLT members observed as follows:
 
“…it is concluded that the legislative intent behind enacting both the LLP Act 2008 and the Companies Act, 2013 is to facilitate the ease of doing business and create a desirable business atmosphere for companies and LLPs. For this purpose, both the Acts have provided provisions for merger or amalgamation of two or more LLPs and Companies. The issue involved in the present petition has been categorically dealt with by the Companies Act, 1956 but there is no specific provision in the Companies Act, 2013. Therefore, this is the clear case of casus omissus. If the intention of the parliament is to permit a foreign LLP to merge with an Indian Company, then it would be wrong to presume that the Act prohibits a merger of an Indian LLP with an Indian Company. Thus, there does not appear any express legal bar to allow/sanction merger of an Indian LLP with an Indian Company.”
 
The above ruling paves the way—from the perspective of company law—for the merger of an LLP into a Company. However, the tax implications associated with such a merger could be as follows:

Capital gains tax implications in the hands of the LLP

As per section 45 of the Income-tax Act, 1961 (the ITA), the profits or gains arising from the transfer of a capital asset is chargeable to income-tax under the head “Capital gains.” The assets of the LLP stand vested in the Company upon merger, and accordingly, the tax authorities may regard it as the transfer of a capital asset; hence, it is chargeable to capital gains.  As per section 48 of the ITA, the income chargeable under the head “Capital gains” is computed by deducting the cost of acquisition of the asset from the full value of the consideration received or accruing as a result of the transfer of the capital asset. Accordingly, one needs to ascertain the consideration received by or accruing to the LLP as a result of the said merger.

The consequence and statutory standing of a scheme under sections 391 to 394 of the Companies Act came up for consideration before the Bombay High Court in Sadanand S. Yarde v. State of Maharashtra (2001) 247 ITR 609 (Bom). The Bombay High Court held that a scheme of amalgamation has statutory operation when sanctioned by the company court under the relevant provisions of the Companies Act and is distinct and different from a mere agreement signed by the necessary parties. Even if the scheme is approved by all concerned parties by consensus, merely because it is so agreed upon, the court is not obliged to put its imprimatur on it. The court has the discretion and power to reject a scheme even if all the shareholders and creditors have agreed to it. Once the company court scrutinises the scheme and sanctions it under section 391 of the Companies Act, 1956, the scheme ceases to retain the character of a contract and operates by force of the statute. The High Court further observed as follows:
 
“It is true that in a case of amalgamation, there is a share exchange ratio prescribed according to which the shareholders of the transferor company would be entitled to the shares of the transferee company. ……, it would appear that in an amalgamation, no consideration in any form much less in the form of money—flows from the transferee company to the transferor company, which was the erstwhile owner of the assets. The shares are issued by the transferee company, not to the transferor company, but to the shareholders of the transferee company, who must necessarily be treated as distinct from the transferor company itself. The shareholders of the transferor company could not be deemed in law to be the owners of the assets of the transferee company, nor can they be said to have held any interest in the assets of the transferee company….” 
Based on the above, it is clear that in a scheme of amalgamation, no consideration flows from the Transferee Company to the LLP, which was the erstwhile owner of the assets. Accordingly, where no consideration flows to the LLP, one may argue that no capital gains should arise in the hands of the LLP upon merger of the LLP into the Company. 
 
Section 47 of the ITA, which exempts certain transfers to which the provisions of section 45 shall not apply, inter alia includes transfer of assets in a scheme of amalgamation of a company with an Indian company. There is no explicit exemption for the transfer of assets upon merger of an LLP into a company. Accordingly, the tax authorities may not accept the above, and instead, seek to tax the transfer in the hands of the LLP.

Capital gains tax implications in the hands of the partner of the LLP

As part of the scheme of amalgamation, the partners of the LLP will receive shares in the Company. This may be regarded as the extinguishment of the rights of the partner in the LLP in consideration for shares, and accordingly, taxable as capital gains.
While the income-tax laws explicitly provide for the tax neutrality of amalgamation and demergers, both in the hands of the company and shareholders, the law as it stands today, does not contain similar exemptions for the merger of an LLP into a company or vice versa. While the ruling of the NCLT permitting the merger of an LLP into a company is a step in the right direction from the perspective of ease of doing business, it is imperative that tax neutrality is afforded to such mergers to boost the government’s efforts in facilitating the “Ease of Doing Business.”
Disclaimer: This article includes inputs from Parag Doshi, Executive Director – M&A Tax, Akshay Shenoy, Director M&A Tax PwC India, Manish Gupta, Manager, M&A Tax PwC India and Samyak Shah, Associate, M&A Tax PwC India.

 

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