Conversion of Sole Proprietorship to a Company is not a transfer & Exempt from capital gains tax
Conversion of Sole Proprietorship to a Company is NOT a transfer & is Exempt from capital gains u/s 47(xiv) subject to some stipulations.
Here is one case wherein the same issue was discussed. The same is as under:
DCIT v. Jaspalsingh Prehaladsingh Chandok 2023-TIOL-4519-ITAT-MUM
Let us have a Short Overview of the Case:
Facts of the Case:
– The case involves M/s Balu India (sole proprietorship) which was succeeded by M/s. Balu Forge Industries Ltd under a Business Succession Agreement.
– In return, the proprietor received 4,78,40,000 shares (62.72% of the total shares) in the company, totaling Rs. 47.84 crores.
– The assessee claimed an exemption under Section 47(xiv) of the Income Tax Act, which allows CG exemption when a sole proprietorship is transferred to company under certain conditions.
– However, the AO rejected the claim, alleging non-compliance with required conditions.
– The matter was then appealed to CIT (A) & CIT (A) gave the decision in favour of the assessee whereas revenue appealed against the order to ITAT.
Judgment Analysis:
– Transfer of Assets & Liabilities: AO claimed non-compliance with Section 47(xiv) due to asset valuation discrepancies, including goodwill.
– CIT(A) however disagreed that all the assets & liabilities were transferred to Co. & ITAT upheld CIT(A)’s observation.
– Voting Power: AO argued that the decrease in the assessee’s voting power (from 69.72% to 64.50%) violated the requirement of holding at least 50% voting power under Section 47(xiv), but CIT(A) disagreed, affirming that the voting power remained above 50%, satisfying the condition & the same was upheld by ITAT.
– Preferential Allotments: The AO raised concerns about preferential allotments to the assessee’s sons and others, but ITAT upheld CIT(A)’s decision, ruling that these allotments did not affect the transfer’s validity or exemption u/s 47(xiv).
– Exemption Validity: AO treated the t/f as taxable CG u/s 50B as slump sale, however CIT(A) disagreed & allowed the exemption u/s 47(xiv), ruling that the conditions for exemption were met & ITAT upheld the decision.
The ITAT rejected the AO’s taxable capital gains assessment, emphasizing:
– All assets and liabilities were transferred
– proprietor retained at least 50% voting power. Furthermore, the ITAT clarified that a slight decrease in voting power and preferential allotments did not violate the conditions for exemption under Section 47(xiv).
– In absence of any additional consideration beyond share allotment – all the conditions of section 47(xiv) were compiled and thus, such succession of proprietorship to company is not transfer and exemption u/s 47(xiv) is applicable.
The copy of the order is as under:
