Conversion Of Partnership Into A Company

Updated: May 5 2003, 05:30am hrs
Corporatisa-tion is the need of the hour. The entire world is gradually drifting towards one global market without any trade barriers between the countries. A small organisation led by few partners cannot think of growth on large scale without corporatising itself. Corporatisation have their own advantages such as Limited Liability, Perpetual Succession, Transferability of shares Expansion, etc. Sections 565 to 581 prescribes the law and procedure for Companies authorised to Registrar under part IX Companies Act, 1956. Section 565 of the companies Act 1956 provides that any company formed in pursuance of any Act of Parliament other than Companies Act, consisting of seven or more members may at any time register itself under the Companies Act, either an unlimited company or as a company limited by shares or limited by guarantee.

Section 566 defines a joint-stock company to mean a company having a permanent paid up capital of fixed amount divided in to shares, also of fixed amount. Section 568 provides the documents to be delivered to Registrar companies for registration as per Part 1X of any company not being a joint stock company Clause (b) of section 568 refers to deed of partnership or other instruments constituting or regulating the company. Section 575 of the Companies Act, provides that in part 1X conversion, the property passes to and vests in the company. Circular No. 5/99 dated 19-5-99 vide file 17/45/98. CLV and Press Release dated 5/8/99, clarified that, the Registrar of Companies will continue to Register Partnership Firms under Part IX of the Companies Act as Joint Stock Companies on satisfying the procedure and conditions. Accordingly, an existing Partnership Firm can be registered under the Companies Act. In a landmark Judgement of the Bombay High Court, in, CIT v M/S Texspin Engg. & Mfg. Works (ITA no 222of 2001 dated 5-3-2003)(unreported) after considering the provisions of Companies Act, provisions of income tax relating to capital gains and relying on the ratio of Malbar Fisheries Company v CIT (1979) 120 ITR 49 (SC), CIT Vs. George Henderson & Co Ltd (1967) 66 ITR 622 (SC), CIT Vs. Gillanders Arbuthnot & Co (1973) 87 ITR 407 (SC), held that, when a firm register as company, as per the procedure prescribed under part IX of the companies Act no capital gain tax arise to the firm. When a partnership firm is treated as limited company, under part IX of Companies Act, the properties of the erstwhile firm vests in the limited company as they exist, there is no dissolution, hence neither section 45 (4) nor section 45 (1) of the income tax is applicable. When shares of Companies allotted to Partners in consideration of Capital standing in their accounts in the firm there is no transfer of capital assets as contemplated under section 2(47) (iii) of the Income Tax Act (i.e. compulsory acquisition, thereof under any law) of the Firm to the Company, as partners are getting their own right to share Capital. In Will Pack Packaging Vs. Dy. CIT (2003) 78 TTJ (Ahd.) 448 also taken the view that, corporatisation of the firm under the part IX route did not attract liability to Capital Gains in the hands of the firm. In Vali Pattabhiram Roa v Shri Ramaniya Ginnning &Rice Factory (P) Ltd. (1986) 60 Comp cas 568 (AP), the Court has held that there is no transfer under general law if the constitution of the firm is changed in to that of company by registering it under part IX of the Companies Act, as there shall be statutory vesting of title of all the properties of the firm in the newly incorporated company without any need for a separate conveyance, section 5 of the Transfer of Property Act is not attracted, even stamp duty is not leviable. As per the explanatory memorandum to the Finance (No. 2) Act, 1998, [235 ITR (St.) 35 (58), the exemption form the levy of Capital Gains in cases of business reorganisation was brought out on the basis of the recommendation of the Expert Group. The Finance (No.2) Act, 1998, has inserted section 47 (xiii) with effect from 1st April 1999, to exempt the transfer of business on conversion of partnership concern in to company. This mode of conversion is now preferred mode, as there would be no Capital Gain tax liability. However, various restrictions like, continuation of 50% of total voting power in the company, and their shareholding to minimum period of five years from the date of succession will have to be satisfied. As regards the levy of stamp duty on such conversion is also not free from doubt. Similarly, if the business is carried on tenanted premises if the firm is converted in to corporate, the consent of land lord may be required, in view of the ratio laid down by the supreme court in General Radio &Appliances Co Ltd v Khadar (MA) (1986) 60 comp cas 1013 (SC). In a case where a firm is registered as per the procedure prescribed under part IX of the Companies Act, the property vests in the Company by operation of law, therefore, if the Firm has the tenancy which will vest in the Company, by operating Law, hence, the consent of the land lord may not be required. Section 3 of the Gift tax is ceased to apply with effect from 1-10-1998, hence, before conversion to corporate, it may be desirable for the Partners to amend the profit sharing ratio, or Capital ratio or may Revalue the immovable assets, Trademark, etc to determine the correct worth of the firm and may issue shares accordingly. Considering the advantages, those who desire to convert, firm into a company, the part IX route under the Companies Act seems to have many advantages comparing with other modes of conversion.