Merger of an LLP with a Company - An 'Evolutionary' Decision by NCLT

There have been a large number of mergers between companies under the Companies Act, 2013/ Companies Act, 1956 but it’s rare to come across a proposition of a firm or an LLP merging into a company. The National Company Law Tribunal, Chennai Bench (‘NCLT Chennai’), has now allowed an LLP to merge with a company[1].

Under a Scheme of Amalgamation, Real Image LLP (‘Transferor LLP’) was proposed to be amalgamated and vested with Qube Cinema Technologies Private Limited (‘Transferee Company’) on a going concern basis. The Transferor LLP was incorporated and registered under the provisions of Limited Liability Partnership Act, 2008 (‘LLP Act’), whereas the Transferee Company was incorporated and registered under the Companies Act, 2013. Both the entities were engaged in the same business; further, the Scheme provided for the transfer of the whole of the undertaking of the Transferor LLP comprising its business, all assets, all liabilities and all rights, title and interest in immovable properties to the Transferee Company on a going concern basis.

This article seeks to focus on the attendant implications both from a regulatory and tax standpoint.

Provisions relating to mergers of companies/ LLPs:

Under the Companies Act:

Under the Companies Act, 2013:  Section 230 to 232 of the Companies Act, 2013 deals with the provisions relating to compromises, arrangements and amalgamation between companies and its members/ creditors and section 234 of the Companies Act, 2013 allows a foreign company, including body corporate (such as LLP), incorporated outside India, to merge with an Indian Company or vice versa.

Under the Companies Act, 1956:  Section 391 to 394 of the Companies Act, 1956 (corresponding to section 230 to 232 of the Companies Act, 2013) dealt with the provisions relating to compromises, arrangements and amalgamation between companies and its members/ creditors. Importantly, section 394 of the Companies Act, 2013 allowed a body corporate (such as LLP) as a transferor entity in a scheme of amalgamation to merge with an Indian Company.

Under the LLP Act:

Section 60 to 62 of the LLP Act deals with compromises, arrangements, reconstruction and amalgamation of LLPs which are identical to the provisions of Companies Act, 2013. 

Under the Companies Act, 2013 and the LLP Act, NCLT is empowered to sanction the scheme of amalgamation of companies or LLPs.

The provisions of the Companies Act, 2013 and the LLP Act, 2008, provide for amalgamation of companies with other companies and LLPs with other LLPs under the respective Acts and the interconnect between the two i.e. merger of an LLP with a company or vice versa is neither specifically permitted nor is specifically prohibited. LLPs.

Issue before NCLT Chennai and certain other decisions:

NCLT Chennai had the opportunity to address the said lacuna and the lack of interconnect in the aforementioned Scheme of Amalgamation between the Transferor LLP and the Transferee Company.

NCLT Chennai sanctioned the said Scheme and observed that that the legislative intent of enacting the LLP Act, 2008 and the Companies Act, 2013 was to facilitate ease of doing business and creation of a desirable business environment. Under the Companies Act, 1956, there was an express provision[2] wherein ‘transferor company’ included any body corporate. However, there is no similar provision under the Companies Act, 2013. Since, merger of a body corporate (including LLP) with an Indian Company was categorically covered under the Companies Act, 1956 and there being no specific provision under the Companies Act, 2013 to provide for the same, it was a reckoned to be case of ‘casus omissus’ i.e. a case which was omitted to be included but which would otherwise have been included given that the same was specifically provided for in the erstwhile law. NCLT Chennai further held that, if the intention of parliament was to permit merger of a foreign LLP with an Indian Company[3] under the Companies Act, 2013, then it would be wrong to presume that the said Act prohibits a merger of Indian LLP with an Indian Company. Accordingly, NCLT Chennai held that there is no express legal bar to allow/ sanction the merger of an Indian LLP with an Indian Company.

NCLT, Mumbai Bench, had also allowed the merger of an LLP into a Company[4], although the question, whether a firm/ LLP can merge with an Indian Company, was not discussed in the said decision i.e. the issue whether it was possible or not was not before the NCLT. It is to be noted that although the sanction of the Scheme of Amalgamation was under section 230 to 232 of the Companies Act, 2013, the said Scheme was originally filed with the High Court under section 391-394 of the Companies Act, 1956 and was then transferred to the NCLT when it assumed the jurisdiction over sanctioning schemes of amalgamation/ arrangement.

Interestingly, NCLT Ahmedabad Bench[5] (NCLT Ahmd), had also discussed the same issue, in the context of a partnership firm (admittedly, not a body corporate), wherein one of the transferor entities, being a partnership firm registered under the Indian Partnership Act, 1932, was proposed to be amalgamated with an Indian Company. NCLT Ahmd held that a registered partnership firm is not a ‘company’ within the definition of Companies Act, 2013 and therefore, not permitted to be merged with another company. Also, the fact that there is no specific provision for a ‘body corporate’ to participate in the scheme of amalgamation under the Companies Act, 2013, the legislature in its wisdom thought it fit to make available the provisions of compromises, arrangements etc only to companies and not body corporates. NCLT Ahmd further held that the provisions of section 234 of the Companies Act, 2013 dealt exclusively with cases involving foreign companies and the benefit of explanation to section 234(2)3 cannot be extended to a partnership firm, not being a body corporate incorporated outside India. Thus, NCLT Ahmd answered on the issue under consideration in negative.

An important decision which NCLT Ahmd discussed was the decision of the Kerala High Court[6] which had approved a Scheme of Amalgamation under the provisions of Companies Act, 1956, wherein a partnership firm was allowed to be merged with a company, following an earlier decision of the Bombay High Court[7]. The Bombay High Court had observed that under the Companies Act, 1956[8], a partnership firm is treated as an ‘unregistered company’; and therefore, as per section 390 of the Companies Act, 1956 (dealing with interpretation of sections 391 to 393) which defines a company to mean any company liable to be wound up under this Act,  the Bombay High Court and thereafter, the Kerala High Court had held that a partnership firm could thus amalgamate with a company under section 391 to 394 of the Companies Act, 1956. Since the decision was rendered interpreting the provisions of the Companies Act, 1956, NCLT Ahmd held the same as not applicable to the case, as there is no similar provision under the Companies Act, 2013, whereunder the application for sanction of scheme of amalgamation was made.

It is noteworthy to mention that there was no reference to any of the above decisions in the order of NCLT Chennai while considering the issue of merger of an LLP with a company.

Considering that the different benches of NCLT have taken views, which do not seem to be aligned, it would be advisable if the issue of merger of firm/ LLP with a company is clarified or alternatively, appropriate enabling amendment be carried out under the Companies Act, 2013 by the Ministry of Corporate Affairs. Logically, there seems to be no reason why this should not be permitted.

The Tax Conundrum:

From the perspective of the Income Tax Act, 1961, (‘ITA’), the definition of amalgamation[9] defines merger in the context of companies. A company is defined, inter alia, to include an Indian Company i.e. formed and registered under the Companies Act and foreign body corporates. It however, does not deal with a situation of amalgamation of a firm/ LLP (incorporated in India) with a company or vice-versa. Thus, the specific exemptions provided under the ITA[10], revolving around ‘amalgamation’ as defined in the context of companies, may not be available and thus tax neutrality on transactions involving amalgamation of firm/ LLP into a company seems, prima facie, to be an issue.

Having said that, let’s evaluate the taxability of merger of a firm/ LLP into a company, from three angles – transferor firm/ LLP, the partners and the transferee company.

In the hands of the transferor firm/ LLP:

In the case of a merger, the entire business, including all its assets and liabilities, are transferred and vested in the transferee company on a going concern basis. It is a well settled principle that a business undertaking is a capital asset and thus, the tax department may seek to compute capital gains in the hands of the firm/ LLP on amalgamation.

However, one may argue that vesting of such capital asset is nothing but a succession of business of the firm/ LLP by a company on account of merger and thus take shelter of the provisions of section 47(xiii) of the ITA, which provides that capital gains will not be charged on any transfer of a capital asset by a firm (including LLP) to a company as a result of succession of the firm/ LLP by a company in the business carried on by the firm/ LLP, subject to fulfilment of certain conditions prescribed thereunder.

Though the above position is litigious, there is a strong case to contend that there is no capital gains accruing in the hands of the transferor firm/ LLP and therefore, there should not be any capital gains exigible to tax under section 45 of ITA.

In the hands of partners:

As far as the partners of the firm are concerned, the partners give up their ‘rights’ in the interest of the firm/ LLP and as a result of merger, they “receive shares in the transferee company. The tax department may accordingly seek to compute capital gains by treating the difference between fair value of consideration received by the partner and the cost of acquisition of ‘partnership interest’ in the firm, in the hands of the partners.

In this situation, one may argue that there is no ‘transfer’ of rights by way of extinguishment in the hands of the partners as they, in a different form, would continue to exercise the same rights over the transferee company upon issue and allotment of shares by the transferee company. Reliance may be placed on the decision of Hon’ble Bombay High Court[11] (in the context of conversion of partnership firm into a company) which concurred with the decision of the AAR which had in turn held that the shares allotted to the partners of the firm consequent upon registration of firm as a company, did not give rise to any profit or gains. While rendering its decision, AAR also, inter alia, observed that the worth of the shares of the company so allotted was not different from the interest of the partners in the existing firm. However, the Bombay High Court did not apparently deliberate upon the ratio laid down by the Supreme Court[12] wherein it was held that that extinguishment of rights of the shareholder in the shares of the transferor company in case of an amalgamation results in ‘transfer’ of shares within the meaning of section 2(47) of the ITA.

It may be argued that a scheme of amalgamation once approved by the NCLT, under the provisions of section 230 - 232 of the Companies Act, 2013, the underlying business undertaking (capital asset) automatically gets vested in the transferee company as per the statutory mandate of the law. Hence, one may take a stand that the partners have not made any gains or received any profits on account of merger. Having said that, the above situation is highly litigious.

In the hands of transferee company:

Section 56(2)(x) of the ITA deems income in the hands of any person, being a recipient of any sum of money, ‘immovable property’ or ‘property’ for no consideration or inadequate consideration. In the present case, since the transferee company is in receipt of a capital asset, being a business undertaking and ‘business undertaking’ does not fall within the definition of the term ‘property’[13], there is no provision under the ITA for the tax department to widen its tax net to deem income in the hands of transferee company. In any case, the transferee company has issued (adequate) consideration in the form of shares as against the value of business undertaking received.

Apart from the above, challenges like WDV for the purpose of computing depreciation of individual assets received as a part of business undertaking, cost of shares received by the partners of account of such merger, period of holding of shares, carry forward of losses of the transferor firm etc, will definitely remain a question.

Concluding Remarks:

The decision of NCLT Chennai is an evolutionary step in the jurisprudence of corporate law which has recognised the importance of ease of doing business and creation of a more conducive business environment.

The fact is that business restructuring has become very critical in the challenging environment that we live in today, especially where business houses continue to grow inorganically by way of mergers and acquisitions and therefore, the need for clarity on the legal and tax aspects is very crucial. In this context, it should be appropriately clarified/ amended (possibly with certain conditions to safeguard economic interest of the Government as is provided in case of amalgamation/ demerger between companies) to address the issues that may arise on account of such business restructuring which would reduce the difficulties being faced today on account of ambiguity; clearly this would be an important step in the Government’s agenda of improving ease of doing business.

* This article has been co-authored by Mr. Darshan Khandhar with inputs from Mr. Binoy Parikh.

[1] CP/123/CAA/2018 (TCA/157/CAA/2017) [dated 11th June, 2018] 

[2] Section 394(4)(b) of Companies Act, 1956 defines ‘transferor company’ to include any body corporate, whether a company within the meaning of this Act or not. 

[3] Explanation to section 234(2) of the Companies Act, 2013, which deals with mergers or amalgamation of company with foreign company, states that ‘foreign company’ means any company or body corporate incorporated outside India whether having a place of business in India or not. 

[4] TCSP 190 and 191 of 2017 [dated 23rd March, 2017] 

[5] CA (CAA) No. 95/NCLT/AHM/2017 (order dated 22nd September, 2017) 

[6] Manjilas Agro Foods Private Limited & Others (Company Petition No 30/2014) [dated 29th March, 2016] 

[7] Kirtilal Kalidas Diamonds Exports Pvt Ltd (148 Comp Case 607) [dated 29th February, 2008] 

[8] Section 582(b) of the Companies Act, 1956 defines ‘unregistered company’ to include any partnership, association or company consisting of more than seven members at the time when the petition for winding up the partnership, association or company, as the case may be, is presented before the Tribunal. 

[9] Section 2(1B) of the ITA 

[10] Section 47(vi) and 47(vii) of the ITA 

[11] CIT vs Umicore Finance Luxembourg 291 CTR 174 (Bombay) [2016] 

[12] Grace Collis vs CIT 248 ITR 323 [2001] 

[13] Explanation to section 56(2)(x) read with explanation (d) to section 56(2)(vii) of the ITA