Jan-Feb 2008 Vol 3 Issue 1
PRESIDENT’S MESSAGE
INSIDE THIS ISSUE:
Let me wish you all a very Happy and Prosperous New year 2008. We the CAs as a group are said to have a fascination for numbers. The Year 2008 is one to note that it is a leap year. May this year bring a leap in the happiness, success and achievements of one and all .It also marks the completion of two successful years of our journal : “AUDITOR” - Full Credit goes to the editorial team for its efforts and to the sponsors. Now that the hectic schedule of visits to the income-tax office for attending time barring assessments is over , it is time to cool our heels and let festivities of Pongal take over. I am happy to share with you that a lot of members have evinced interest in hiring our Conference hall in response to our message published in the previous issue. The Society along with SIRC and D.Rangaswamy Academy for Fiscal research jointly hosted a meeting for celebrating the birth anniversary of Late Sri.D.Rangaswamy ,Past President of our Society. Dr. S.S.Badrinath, the great doyen of the medical profession gave his insights on the costing system in the Healthcare industry. It was a real eye opener in more ways than one that even Lord Varuna could not resist peeking in.
President’s Message & Editorial
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Secretary’s Report
2
Sharp Questions & Blunt Answers
3-5
Conversion of Partnership Firms into a Company
6-7
Annual Conference of Society of Auditors
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Today with the advancements in technology and globalization nothing remains the same forever. Change is the only constant thing in life. As the Queen told Alice in Alice in Wonderland, you have to keep running to stand in the same place. As professionals , we need to constantly refresh our knowledge and keep updating ourselves by taking active part in the various programmes conducted by the society. Our Society is organizing a One-day Conference on 16th February 2008 at TAG Centre, TTK Road, Chennai-18 and the discussions will be on important subjects for members in practice and industry. I look forward to your participation and valuable contribution for the success of the conference by enrolling as a delegate along with your professional colleagues. The Society has taken initiatives to revive the regular meetings with the income tax department to enable the members to interact with the officials and get their viewpoints on matters affecting practice. I also take this occasion to emphasise on increasing the society membership by bringing more professionals to our fold. With Best Wishes, CA.S.SANKARAN
EDITORIAL With the dawn of the New Year, AUDITOR steps in to its third year. While AUDITOR wishes all of you a very happy 2008, it also seeks your blessings and continued patronage. With very little advertisement support but with no compromise on the quality of paper and printing or in the quality of the content, AUDITOR continues in its path and with its usual verve. It has been a matter of slight disappointment that the feedback from the members have been far and few, but I have always said to myself that reticence has, for ever, been the hallmark quality for Chartered Accountants, except when they want to 'qualify' - a term, when used by them, isn't exactly pleasant! However, the last issue proved different. There was a spate of phone calls from many members on the first part of the interview with Mr T.N. Manoharan published in the last issue. Looks like a lot of members had similar questions in their mind about the Institute! 1
(Mr TNM himself called and informed that he too received numerous appreciative calls.) A couple of 'conformists', for whom the adage that 'King can do no wrong' is sacrosanct, weren't too thrilled and expressed their surprise that we had the nerve to pose such questions. To them, I would humbly submit that the first part was the milder one. The second and the steamier part of the interview is brought to you in this issue. We asked questions on Institute elections, practice of co-options, logo, financials of the ICAI etc. to Mr Manoharan and you will see that without a wee bit stepping out of the deep sense of responsibility both to the position he held and to his conscience, he gave sanguine replies, though some of them not in sync with our proclivities! We have said as much even during the course of the interview only to elicit chirpy laughter spells! Tax is the staple diet for us, practitioners and for any subject in our vast domain, we have to necessarily give the tax edge! When Sri NS Srinivasan sent in his brilliant treatise on Part IX
conversion, we requested him to wrap up with a discussion on the tax implications. You will find him obliging us in this issue. President Mr Sankaran is upbeat about the ensuing Annual Conference of the Society and all the members are requested to enroll as many delegates as possible to make it a memorable one. Year's beginning brings with it change of guard in the Central Council and in the Regional councils across the nation. We wish the new incumbents and more specially the vivacious Rajendrakumar at SIRC a wonderful term. By the time the next issue of Auditor will be out, the Chidambara Rahasyam would be out too. I am very confident that we will have enough fodder to chew for several seminars and meetings in the first few months, adequate heartburn to fret and fume in the subsequent months and a lot of appeals and litigations a couple of years later. That way, our FM will never be frugal! Cheers — P.S.Prabhakar
Auditor January – February 2008
SECRETARY’S REPORT 'Cometh the Hour, Cometh the Man ' they say so. This is very true of SOA as we had been fortunate to have the 'right men at the correct time' to lead us. The present incumbent I am sure will emulate his illustrious predecessors. He is pulling all stops to make the ensuing Annual Conference on 16th at TAG centre a runaway success. The result will be
there to be seen shortly.
also negotiating with local CPE study circle centres. This reminds me about getting delegates with the vexatious issue of The meeting on ' M and A' adressed we being not allowed to give the by Shri V Srinivasan CEO 3I i much maligned CPE credit. While I Infotech was largely attended and dont have anything against ICAI p r o v e d t h a t c u r r e n t t o p i c s a n d d o l i n g o u t t w o C P E c r e d i t accomplished speakers attracts more programmes absolutely free it beats people. me why we are not allowed to do the I once again appeal to all to attend same for more enriching programmes. the Conference in large numbers and This topic was discussed at length at also Chip in by getting sponsors. our recent Commitee meeting. We had given representations in the past So long then, and maybe try once more. We are S Ramakrishnan
NEW PRESIDENT & VICE PRESIDENT OF ICAI CA. Ved Jain has been elected as the new President of ICAI and CA. Uttam Prakash Agarwal has been elected as the new Vice President of ICAI.
Society of Audiors congratulates them and wishes them a very good term of office.
INSTRUCTION NO. 1/2008, DATED 9-1-2008 Kindly refer to above. 2. Your attention is drawn to the guidelines for selection of cases under scrutiny for the F. Y. 2007-08 under which claim of refund of Rs. 5 lakhs or above is one of the criteria for compulsory scrutiny. Such cases were to be selected for scrutiny by CASS in all the networked stations and manually in nonnetworked stations. 3. Instances have been brought to the notice of the Board wherein cases involving refund of Rs. 5 lakhs or above are not being picked up for scrutiny by the CASS in the networked stations. This happened in cases where credit for prepaid taxes is not being given at the time of processing for want of necessary documentary evidence. Such cases, thereof, do not fall in the category of determined refund of Rs. 5 lakhs or more and consequently are not picked up by the CASS. Subsequently, rectification orders are passed manually on submission of necessary evidence in respect of prepaid taxes and the data is not captured in the AST. As a result, several such cases involving refund of Rs. 5 lakhs or above have been left out of the selection process. 4. I am directed to state that all such refund cases that have been left out by CASS for the reasons mentioned in para 3 above should be picked up for scrutiny through manual intervention in the networked stations. This may be brought to the notice of all concerned for strict compliance. F.No. 225/260/2007- ITA-II Auditor January – February 2008
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SHARP
QUESTIONS
& BLUNT
ANSWERS
A 'STEAMY' INTERVIEW WITH SRI T.N. MANOHARAN .... Continuted from last issue....
On Institute Elections Editor: The present election system (single transferable method) seems to suffer from certain maladies and does not fully reflect the voters' intentions. (There was also an article highlighting the inherent defects in this newsletter earlier). Why is that the Institute is not considering more appropriate options? Is it because that the ICAI's leadership aka Council considers it unimportant or inconvenient? Or is it because such discussions emerge only during election time, when no one has the time to think and die down subsequently, when it is not the time to think? TNM: Every system of election has merits and demerits. In the single transferable voting system, the disadvantage seems to be the long duration of time and the enormous strain on the man power it demands for counting process. Frankly speaking, we have not discussed about any alternative system of election in the Council. Of course, we have explored electronic voting methodology but it required further examination. I had gone through and remember your write up on a different basis of giving weightage in the preferential system and it is an interesting proposition. This can be seriously examined as it would be a good alternative and results can be announced, may be, in a day. Editor: Again on the elections, do you think it could be a good idea, at least to silence the nagging minds of many members in this regard, to insist on members declaring their personal net worth at the time of seeking election, like what happens for legislative and parliamentary elections? TNM: Why not? In fact all the contestants may not mind it. Unlike the general political scenario where lot of room appears to exist to amass wealth by short cut methods, let me say with a courage of conviction, that there are hardly any available in our system. Editor: My last question on elections. And this is because you earlier said that council members get there because of their inner urge. There are some prescribed limits for the election expenses for the contestants to the Council. All of us know that most of the candidates give scant regards to such limits. Some
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contestants give repeated parties, go on trips abroad to secure postal ballots of members abroad, despatch their trusted lieutenants to all over the region, send colourful pamphlets carrying their innumerable photos making even cheap spectacles of themselves. What does Institute's machinery do under such circumstances? If nothing can be done, then why have limits? Why don't we allow them to quench their inner urge at whatever cost? TNM: The monetary limits have been prescribed only recently, i.e. from the last elections. So awareness as well as the consciousness to comply the same will evolve in due course of time. Members being vigilant about it will also bring in more sensitivity among t h e c a n d i d a t e s . U l t i m a t e l y, i n a d e m o c r a c y, w e o n l y g e t t h e representatives we deserve. Unless members are able to qualitatively evaluate the candidature of each
Your write up on a different basis of giving weightage in the preferential system is an interesting proposition - can be seriously examined and would be a good alternative. contestant and accordingly vote, issues of this nature will continue to haunt us. Let us hope that things will turn out to be better and better in the days to come.
CA Prefix, the new Logo and Council meetings Editor: You were instrumental in the Brand Building efforts of CAs. What is that we have achieved by adding the prefix CA to our names? While it is so natural to address some one by the prefix Mister or Doctor and use abbreviations of 'Mr' and 'Dr' while writing, don't you consider it strange to use the prefix “CA� in writing and also addressing them with the same abbreviation like CA Prabhakar or CA Manoharan? Why is this idea simply thrust on members? TNM: First of all let me clarify that using' CA' as a prefix is not mandatory but only recommendatory. I picked up this idea from CA. Narayan Varma ,a senior member of our profession in Mumbai. When this idea was informally shared, there was positive response from across the country . Then it was given shape and debated in the Council and decided. I appreciate the resistance to this move in some section of members. The same reaction must
have crossed even in the minds of many Doctors in the initial stages when 'Dr' was introduced as a prefix. Questions must have been raised as to why it should be used in the place of 'Mr'. In the present day world, branding encompasses several measures .We were conscious that this measure will not per se enhance our image but it is sure to create a distinct identity in the society and differentiate us from other Tax Practitioners. While adherence to Values builds the reputation, measures like this provide identity. In a social gathering of, say 10 persons, if someone is a Doctor, the others do not even call him by his name but they call him by the profession as Doctor, Doctor. I want this to happen to our members in a decade's time. By this move, we have just planted a sapling. Whether it will be nurtured to grow or allowed to perish lies in the hands of the Members. Personally speaking I am amazed at the spontaneous positive response of members across the country, especially among younger members and in smaller places. The other day one young member was proudly telling me that in his ration card his name appears with the prefix 'CA'.. In many meetings people mention the name with the prefix 'CA' as well as 'Mr' without realizing that 'CA' replaces 'Mr'. Such a step takes time to get itself the acceptance it deserves and the usage it merits. Till then these debates are necessary and will go on. Editor: Even in the matter of logo, don't you consider that - in the days of CAAT, System Audit, e-filing etc and when even small business entities have switched over to a completely computerized environment, by keeping a traditional audit tick mark, used in the last millennium on books and ledgers we are professing to the world that we have not 'come of age'? TNM: In fact, when I was the President, there were feedbacks from some members not to use tick mark in the logo as these days a CA is emerging as an advisor /consultant and that is why it was deferred last year in search of better designs. This being a
Auditor January – February 2008
logo for members for eternity it was felt that collective wisdom needed to be applied and should not be rushed through. In any case, now that the design has been approved and officially released we may adopt it. Again, this is recommendatory. E d i t o r : B u t , S i r, y o u s a y i t i s recommendatory but Institute itself has begun using it in its Journal, giving an 'official' status to it. However you seem to be simply defending the decision because it stands decided and that once council approves something no one can disapprove. Let me ask you something about the Council discussions that lead to such decisions of 'collective wisdom'. The transcripts of even the Lok Sabha and Rajya Sabha discussions are available in the public domain. So, why can't the Institute think of publishing the transcripts of the Council meetings in the website? At least this way, members can be made aware of the 'contributions' of their elected representatives? TNM: These things would evolve over a period of time. In the olden days there was no telecasting of Parliament proceedings but people were keen to know what transpired. Later when the facility has been provided no one seems to be interested in watching. The same may happen in our case too. Members of the profession are intelligent enough to know the caliber of their representatives even without these transcripts. In a few years down the line, disciplinary proceedings which are confidential in nature will not be dealt with by the Council and will be dealt with only by Board of Discipline and Tribunal. At that time the volume of business transacted by the Council will be drastically reduced when this suggestion may be feasible for adoption.
IFRS… IFRS…. IFRS….! Editor: A lot of talk is always going on IFRS convergence and it is agreed that in these days of 'default globalisation', there is really a need for the international community of accountants to speak in one language. But, why do we have to always adhere to the 'cut-copypaste' approach, by always being suggestive about 'adoption of IFRS standards'? Why can't the Institute look seriously at the uniqueness of our business cultures, the family orientation of business entities, the fact that ours is more a debt driven e c o n o m y, t h e e x t e n t o f o u r countrymen's exposure to stock markets etc. and design countryspecific Accounting Standards, rather
Auditor January – February 2008
than simply aping the IFRS? Why is that the ICAI is bending backwards (it is really amusing to read the para in the ICAI report on the proposed convergence with IFRS) to sacrifice our identity, without even evaluating the suitability of IFRS? Are we so bereft of originality? TNM: Convergence has happened faster in Economies which either did not have their own accounting standards or where the standard setting process is not well established. In India that is not the case. Therefore, Convergence can not be done overnight. Convergence can not also be achieved unilaterally but needs to be piloted by ICAI with the support of the Government and Regulators in the country. Keeping this in view, during my President ship a Task Force was constituted to study and recommend to the Council by preparing a concept paper and a road map in this regard. Based on the recommendation of the Task force, now the Council has taken a view that convergence will be achieved by 2011-similar to the stand taken by Canada. In my view, with the
Convergence has happened faster in Economies which either did not have their own accounting standards or where the standard setting process is not well established. ever increasing cross border transactions and India turning out to be global destination for investments, convergence is unavoidable. But what we should aspire to achieve is to secure position and role in the formulation of IFRS. We are 1.2 billion population out of 6.1 billion population of the World and thus have 1/6th of human size besides being one of the fastest growing Economy. We cannot be merely adopting without a hand in the formulation. No doubt we have some representatives from the Country but not nominated by ICAI. We have raised this in appropriate quarters and hope to get due recognition.
Institute's accounts Editor: The system of governance of our ICAI is that we have a Central Council and many Regional Councils. The Regional Councils have a decentralized system of functioning and separate accounts are prepared and AGMs are convened to get the accounts adopted by the members. Why is that system cannot be followed in respect of the Annual Accounts of ICAI, of course with due changes to suit the logistics? The Annual Report says that the Council
approves the ICAI's accounts. How can the Council, which prepares the accounts also approve it? Isn't there a serious ethical issue involved here? TNM: These aspects are governed by the provisions of the Chartered Accountants Act and Council has no o p ti o n o n th i s . I n a n y c a s e , th e accounts are audited by a Chartered Accountant and there is provision for Special Audit to be conducted if the information is brought to the notice of the council that the accounts do not represent true and fair view either directly or through the Central Government. Besides, there are Government nominees as part of the Council. So these aspects taken holistically seem to serve the purpose. Editor: On a glance of the accounts, we find that the body which prescribes Accounting Standards to the entire nation is itself not following many Accounting Standards. Let us take for instance, AS-17. Why can't the Institute give segmented information on revenues and expenditure? Out of the total income to the tune of Rs. 145 Crores, the Students segment alone seems to have contributed over Rs. 100 Crores, whereas out of the total expenditure of about Rs. 110 Crores, not more than Rs. 25 Crores have been spent for the students. If only segmented info is available, these could have been clearly disseminated. Is AS only for others? TNM: This issue was examined and a conscious view was taken that AS 17 is not applicable to the ICAI as there is only one segment within the ICAI. One cannot bifurcate members and students as two segments as they are interwoven at all levels. The entire establishment expenses are commonly incurred. You just can not take Board of Studies and examination section in ICAI and believe that only they are dealing with the students. If the expenses incurred at all levels, both direct and indirect, is even roughly estimated, the figures will not reflect such a topsy turvy position shown in y o u r q u e s t i o n . We s h o u l d a l s o appreciate that still CA course the most economical course in the Country. Further, I must mention that huge capital outlay is contemplated for education and training of Students in the form of e-learning and infrastructure development. Editor: Recently, membership fees have been substantially increased. What was the need when the Institute finished last financial year with a surplus of Rs. 35 Crores? Are we running an organization for profit?
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TNM: ICAI is non-profit organization is a fact known but that does not mean that we should not make surplus at all. If this philosophy is mandated then there is no need for granting exemption under the Income-tax Act as there would never be any surplus for any Not for profit organization. Surplus is required for any organization, more so for ICAI, in order achieve the desired level growth from the long term perspective. In the past, the surplus was judiciously distributed to Branches and prudently used to acquire and build infrastructure. Today ICAI can boast of being a Professional Body with the best of infrastructure across the country and no other Institution can measure up to our level. Almost 70 branches out of 116 have own properties and in 4 metros we have excellent infrastructure. However, we need to further build Centers of Excellences and Campuses to train and groom Members and Students. Academic and research activities should be housed by creating appropriate infrastructure. During my Presidency, separate grants were created for acquiring land, airconditioning seminar halls, establishing computer labs and existing levels of Building grants were enhanced. These would require enormous funds in the long run. Most of the Branches are now availing the grants to establish computer labs to impart training to students and members. This in turn would convert our branches into Education centers from being mere administrative limbs. This is the justification for the increase in membership fees. All the same when the amendments were made to the CA ACT, it was ensured that ICAI will be in a position to charge different fees for different class of members. That is how senior members are given reduction in fees similar to new entrants.
Co-options – Ritual of Return favours? Editor: Co-options to the various committees have been traditionally the prerogative of the President, who takes in 'suggestions' by Council members? Don't you think that the lofty idea of inducting eminent members who do not take the election route in to committees based on their knowledge, expertise and experience has simply been reduced to a ritual of return favours? TNM: By and large co-options to Committees are based on the profile and expertise of the members. There
will also be nominations not based on expertise but on willingness to spare time to co-ordinate tasks assigned by the committee. Some times experts may not find time even to attend meetings. So a balance is struck. I must say that my experience with coopted members has been excellent in terms of their qualitative contribution.
'Dynamic and Pro active Institute' and the Gen Next Practioners Editor: What is that the Institute planning to do for the new members wanting to enter practice? If Institute does not ensure assignments to them, how can we develop next generation practitioners? TNM: I do not know whether a similar question can be asked to The Medical Council or Bar Council or Engineers Council or any other professional body. Why that such an expectation is directed towards ICAI? Is it because it is dynamic and pro active? ICAI is expected to empower the students and
it is not the duty of ICAI to ensure flow of assignments to them (young members). It is the duty of members in practice to develop their successors. turn them into quality members. It should also facilitate that the members are equipped with continuing education to sustain and maintain standards in their functioning. But it is not the duty of ICAI to ensure flow of assignments to them. It is the duty of members in practice to develop their successors. Firms should have a succession plan in place to attract talent, to develop and retain them. In the present scenario, as I perceive, lack of work is not an issue at all but lack of skill sets to do the works flowing in is the issue. ICAI and Firms should empower members with the skill sets required in newer areas by conducting training workshops. I am sure the cycle will repeat after a few years when you will find more youngsters entering practice and lesser opting for jobs. Market has its own ways of striking a balance in a potential Economy like ours.
Yours Obediently by Law Editor: ICAI is the premier institution in the country that is not living out of any Government subsidy nor needs any Governmental patronage. So, why it cannot, give
press releases and comments in media on the various happenings in the Financial and Economic fronts? Even when the budgets are pathetic, there is not even generally a word of even a mild criticism by ICAI? Why?
TNM: ICAI is set up under an ACT of Parliament. It is considered as part of Government like any other regulator with certain objectives and powers. Just as SEBI or RBI cannot criticize the Government, ICAI cannot also criticize. But ICAI is free to make representation to the Government or assist the G o ve rn m e n t i n p ol i c y m a k i n g . Wherever factual statements are warranted or implication analysis is done the same can be spelt out. In fact, when Service tax issue came up my statement that it is discriminating between us and advocates was widely carried in the press for which I received mails from many members including yours appreciating the stand taken. S i m i l a r l y, t h e a p p o i n t m e n t o f Central Statutory Auditors by the Bank Managements was not favoured by ICAI. This decision of the Government was explained as not proper objectively and ultimately it was done by RBI as before. Editor: Sir, thank you very much for your time and for the delightful way of answering the dicey questions. I am aware that though many members would appreciate this interview, when published, some would feel uncomfortable that AUDITOR is treading on areas which it need not. Not only to them but to all the members, including me, Institute is very sacred but I strongly feel that it is not beyond scrutiny. There are complaints that Institute's administrative m a c h i n e r y i s i n d i ff e r e n t t o members' queries and I have personal experience of it. This interview is but a small step to know the insights if not the insides of the institute. Thank you, once again. TNM: It was indeed a wonderful experience answering your questions, Mr Prabhakar. Kindly accept my admiration for your journalistic and linguistic skills displayed now through your thought provoking questions and generally through your editorials.
Auditor January – February 2008
Conversion of Partnership firms into Company under Part IX of Companies Act 1956 Tax Implications CA N.S. SRINIVASAN In the last article, while the procedural aspects of conversion were elaborated in great detail, the tax implications could be highlighted only as a passing reference. However, since there are quite a few issues in this regard under IT Act 1961, they are discussed herein as a separate article:Issue No.1: Whether the aforesaid conversion of firm into a company will result in capital gains tax for the firm or its partners: As already mentioned in the previous article, this aspect was addressed very recently by the Bombay High Court in C I T V s Te x s p i n E n g i n e e r i n g a n d Manufacturing Works (263 ITR 345). In this decision, the Bombay High Court noted that there should be first a “transfer” for charging the same to capital gains tax. Secondly, they noted that for construing a transaction to be a transfer, there should be two essential ingredients, viz. that, there should be a p a r t y a n d a c o u n t e r p a r t y ( Vi z . transferor and transferee) existing simultaneously at the time of transfer and that there should be a consideration passing in pursuance of the transaction qua transferor. The High Court further explained that in part IX conversion, the two parties as stated above do not exist at any point of time. It is either the firm or the company, since the company comes into existence by operation of law only after the firm ceases to exist and till the firm is in existence, there is no company. Thus, the High Court observed that this basic requirement of transfer is absent in part IX conversion and hence, it cannot be construed as transfer as contemplated u/s. 2(47) of IT Act 1961 The next issue was whether this conversion could be subjected to capital gains tax u/s.45(1) itself directly. This was also considered in the aforesaid High Court decision. The A.O had, in this case, adopted the fair market value of the assets as on the date of conversion as the amount of consideration which the court negatived and held that section 45(1) cannot have applicability to this case. Of course the High Court did not consider the issue whether the shares allotted in pursuance Auditor January – February 2008
of the conversion to the erstwhile partners can be taken as the consideration for the purpose of section 45(1). Moreover, a “transfer” of capital asset is always an act of volition of concerned parties. This view gets reinforced due to the provisions of section 2(47)(iii) whereby the legislature had to make a specific inclusion of “compulsory acquisition” as an instance of transfer due to earlier judicial pronouncements that in the absence of transfer out of own volition of parties, compulsory acquisition is not a transfer. In any case, one of the basic requirements of “transfer”, viz., existence of party and counter party is not fulfilled and section 45(1) can apply only if there is a transfer of a capital asset. Hence, even if the consideration element is held to be in existence, section 45(1) cannot apply to Part IX conversion. Finally, the issue considered by the High Court was whether this part IX conversion could be subjected to capital gains tax by virtue of section 45(4). In this regard, the High Court held that neither part IX conversion constitutes dissolution of the firm which is a prerequisite for invoking section 45(4) nor there is a distribution of assets in specie in such conversion which is another requirement u/s.45(4). In this context, the IT Authorities tried to draw support from the enactment of section 47(xiii) to say that always succession of firm by company pre-supposes dissolution of the firm. But even a plain reading of that section makes it clear that the exemption contemplated therein is available only in the case involving the transfer of a capital asset by a firm to a company which pre-supposes both the firm and the company being in existence at the time of transfer which is not the case in part IX conversion. Hence, the applicability of section 45(4) is also firmly ruled out. The High Court categorically held that this is not an instance of succession of a firm by a company. It was explained that while the business entity as such continues even before and after the conversion, what has happened is only a change in status for the purpose of IT assessment. The above decision of the Bombay High
Court was followed by the Bangalore Bench of the ITAT in ACIT Vs Unity Care and Health Services(2007) 106TTJ(BANG)1086. Therefore, it can be concluded for the time being that there cannot be any incidence of capital gains tax on part IX conversion a firm into a company. Issue No.2: Whether the stock on hand should be revalued at market value as on the date of conversion and the consequent surplus to be taxed in the hands of the firm: The Supreme Court held in ALA firm Vs CIT (189 ITR 285) that in the case of dissolution of a firm, the stock in trade as on the date of dissolution have to be valued at market value. But this was the case where the business of the firm ceased in pursuance of dissolution and the partners went for settlement of accounts among themselves. However, in situations where the firm's business continued to be carried on even after the dissolution through reconstitution, the Supreme Court have held that it is enough if the closing stock is valued at cost or market value whichever is less and not necessarily at market value. (Vide Sakthi Trading Co Vs CIT 250 ITR 871). It is apparent that in the case of part IX conversion, the business of the firm continues to be carried on even after conversion into company and hence there is no necessity to revalue the stock as on date of conversion at market value. Issue No.3: Whether the firm and company should file separate income tax returns for the assessment year relevant to previous year in which the conversion takes place: The general principle explained in the Bombay High court decision in Texspin case is that there is absolutely no change in the business entity as a result of conversion. It is only by way of rechristening of the firm into a company. However, for the purpose of income tax assessment, as per section 2(31), “firm” and “company” are considered to be two distinct assessable entities. Hence, only for the purpose of IT Act 1961, it becomes necessary for 6
the firm and the company to file separate tax returns. This means, the firm will have to file a tax return for the period up to the date of conversion while the company will have to file the tax return for the later period till the end of the previous year. Issue No.4: Allowability of depreciation in the year of conversion for the firm and the company: It is to be noted that the decision of the Bombay High Court in Texspin case that there is no “transfer” is only in the context of section 2(47) relating to levy of capital gains tax. It may not apply in the context of section 32. However, in a case where an HUF running the business for part of the previous year transferred their entire business assets to a firm in which the HUF became partner and subsequently the firm continued to carry on the same business, the Madras High Court held that such conversion does not fall within the expression “sold, discarded, demolished or destroyed” as used in section 43(6)( c ) (i)(B) and hence depreciation cannot be denied to the firm. (Vide A.M. Ponnurangam Mudaliar Vs CIT 228 ITR 454). Citing this decision, the Bombay High Court in Texspin case held that the firm can claim depreciation for the period upto the date of conversion. Of course, it goes without saying that on the same principles, the company also can claim depreciation on those assets. However, the issue is what will be the WDV of those assets on which the company can claim depreciation. In the c a s e o f d e m e rg e r o f a c o m p a n y, explanation 2B to section 43(6) prescribes that in the hands of the resulting company, the WDV will be the WDV of the transferred assets of the demerged company immediately before t h e d e m e r g e r. T h e r e a r e s i m i l a r provisions in respect of transfer of assets between holding company and subsidiary company or viceversa as well as amalgamation. But there is no such specific explanation in the case of part IX conversion. Therefore, one is led to the presumption that whatever be the depreciation claimed in the hands of the firm in the year of conversion, the company can claim depreciation on the WDV as defined in section 43(6)( c ). However, if one concedes that under the general principle, the same entity continues, if the firm claims depreciation for the year in respect of 7
the block of the assets, it may not be possible for the company to claim depreciation thereon. Perhaps, for assets acquired during the year on which the firm does not claim depreciation, the company can claim depreciation. Issue No.5: Carry forward of losses from the firm to the company: In the earlier article it was clarified that part IX conversion of firm to a company should not impact the eligibility of carry forward of lossess and unabsorbed depreciation in the hands of the company. However, there is a hurdle for doing so in section 78(2) of IT Act 1961 which says that where any person carrying on any business or profession has been succeeded in such capacity by another person otherwise than by inheritance, then the successor shall not be entitled to carry forward and set off the losses of predecessor. The issue here is whether part IX conversion is an instance of succession or not as contemplated in section 78(2). It was explained earlier by citing Texspin case that there is no succession at all in part IX conversion because as per the scheme envisaged in the Companies Act under Chapter IX, the same unincorporated entity of firm is redesignated as an corporate entity. Only as per the scheme of assessment under the IT Act 1961, the status changes as firm and company. This is because, even for succession, it presupposes that there are two parties to the transaction and that one person should take over the business of the other person. This is absent in part IX conversion. It should be noted that in all instances of succession envisaged under the IT Act 1961 like a m a l g a m a t i o n , d e m e rg e r, s a l e o f business, etc there are two parties to the transaction. Hence, the view that the section 78(2) will not apply in the case of part IX conversion. But there is a contra decision in this issue by the ITAT, Ahmedabad Bench in Amin Machinery (P) Ltd Vs DCIT (111TTJ 892). The learned ITAT Bench in this case has come to this conclusion despite the citing of Texspin case. Hence, the issue is subjected to judicial controversy. While section 78(2) deals with carry forward of losses, doubt arises regarding eligibility to carry forward unabsorbed depreciation. Of course, in the case of succession of a firm by a company in accordance with section 47(xiii), this benefit is made available to the
successor company by section 72A(6) of IT Act 1961. Same is the case re: carry forward of losses as well. If all the conditions specified in section 47(xiii) are fulfilled in the case of part IX conversion also, then the carry forward benefit can be claimed. However, this will undermine the basic principle that part IX conversion is not an instance of succession of one entity by another. EXECUTIVE SUMMARY From the above discussion, it can be seen that the basic issue is whether part IX conversion is a case of succession of one entity by another. If the entity decides to treat it as an instance of succession to avoid judicial controversies, they should take care to fall within the eligibility criteria specified in section 47(xiii). This will also insulate them from capital gains tax incidence on that transaction. At the same time, for the purpose of stamp duty, VAT and excise duty, they can rely on part IX conversion to claim immunity from such levies. On the other hand, if the entity is not having carry forward l o s s e s / d e p re c i a t i o n b u t t h e re i s substantial capital gains tax incidence and also there is difficulty in complying with section 47(xiii) conditions, they can rely on the decision of the Bombay High Court in Texspin case and claim exemption from capital gains tax.
P.S: " In a recent case, before the Gujarat High Court in Mak Business Enterprises –Vs- O.L. of Ambica Mills (141 Company case 535), a partnership firm participated in a court auction for purchase of property and was confirmed the highest bidder on the condition that there should be no nomination of the purchase in favour of anybody else. The firm paid the full amount to the Court but in the meantime, it was converted into a Joint Stock Company under Part IX. Citing this, the O.L. refused to execute conveyance deed of the property in favour of the company saying that it is a case of nomination. However, the High Court held that the Joint Stock Company requesting for execution of sale deed in its favour was the same entity which had made the highest offer and in whose favour the sale was confirmed. This is the latest decision which reconfirms the fact that under general law as well as Companies Act, Part IX conversion of firm into company is not a case of succession. Auditor January – February 2008
ANNUAL CONFERENCE OF
THE SOCIETY OF AUDITORS DATE : 16.02.2008
VENUE : TAG CENTRE, TTK ROAD, CHENNAI 18
DETAILS OF PROGRAMME Registration : 8.55 a.m. onwards Inaugural Address
9.30 10.30 a.m. : Inaugural Session CA K.B. PRANESH, Managing Director, Fivescail KCP Ltd.
First Technical Session: 11.00 a.m. to 1.15 p.m. CHAIRMAN
CA L. VENKATESAN, Chennai
SUBJECT
SPEAKER
Mergers & Acquisitions Advisory Process Certain Nuances
CA R. RAVISHANKAR Connect2Expert, Chennai
Overview of IFRS and significant differences with Indian GAAP
CA CHINNASAMY GANESAN Price Waterhouse Coopers, Chennai
Second Technical Session: 2.15 p.m. to 4.30 p.m CHAIRPERSON
CA B. MALA Partner, Taxation, Deloitte & Haskins, Chennai.
SUBJECT
SPEAKER
Issues in Transfer Pricing
CA N.MADHAN Associate Director, Ernst & Young, Chennai
Recent Trends in Income Tax judgments
CA T. BANUSEKAR, Chennai.
CONFERENCE CO-ORDINATOR: CA B.K. MURTHY : 94440 81586 Delegate Fee : Rs.750/- per Delegate
“Platinum Chambers” 33, TNHB Complex, 4, Luz Church Road Mylapore,Chennai – 600004 Phone: 24986979
Mr S. Sankaran, President Mr Bheema Bhat, Vice President Mr R. Sivakumar, Vice President Mr S. Ramakrishnan, Secretary Mr B.K. Murthy, Joint Secretary Mr V. Swamynathan, Treasurer
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