Company to LLP: the shareholder's capital gain and the reserves

In the most recent decision on this subject the shareholder’s cost of acquisition was fifty thousand rupees and the credit standing against it was over eight crore rupees. That is where the money is, and it is the limb most writing on company to limited liability partnership conversion leaves out.

Section 47(xiiib) exempts the shareholder’s transfer of his shares as well as the company’s transfer of its assets. When the clause fails, the shareholder is a transferor in his own right, charged on the extinguishment of a shareholding that usually cost him a nominal amount years ago. Nothing about the company’s nil computation touches him.

This Part deals with that charge and with the conditions that can be broken after a conversion that did qualify: what actually breaches clause (d) and clause (f), the shareholder’s charge and its character, the reliefs that follow and the ones that are not available, what counts as paying out accumulated profits, sections 9B and 45(4) on a later withdrawal, whether the reserves could be a dividend instead, and the sections 68 and 69 exposure that the successor’s first balance sheet invites. Part 1 deals with eligibility and the charge, Part 2 with the company’s computation, Part 4 with what is lost and with procedure.

Key points

• The shareholder’s gain is usually substantial and is long term if the shares were held long enough, because the asset transferred is the share and not the credit that appears in the partner’s capital account on conversion.
• Section 54F is available against it, but only to an individual or a Hindu undivided family. A corporate, firm or trust shareholder has the rate and nothing more. Section 54EC is not available on shares at all since assessment year 2019-20.
• For a transfer on or after 23 July 2024 the rate is twelve and a half per cent with no indexation on unlisted shares, so the benefit of winning the long term point is the rate and section 54F, not indexation.
• Cost is rarely as simple as the decided case. Shares acquired before 1 April 2001 carry the section 55(2)(b) fair market value option, which survives the withdrawal of indexation; bonus shares have a nil cost; gifted and inherited shares take the previous owner’s cost and holding period.
• Clause (d) is broken by things nobody connects with tax: an outside investor, a retirement, a death, a gift of profit share for succession reasons. Whether a breach brought about by operation of law is a breach at all is unanswered.
• Clause (f) does not bite where no exemption was claimed, on the only decision in point, but that proposition was stated where no clause (f) breach was alleged, and the Revenue’s answer that eligibility is not elective is a real one.
• Withdrawing the reserves afterwards is no longer only a clause (f) question. Sections 9B and 45(4) have to be tested separately, and the clause (f) answer does not reach them.
• Loans the company made to its shareholders in the look back years remain deemed dividend under section 2(22)(e), and which assessee bears that charge depends on the year it was made.

The four parts of this article

• Part 1: is it a transfer, and does section 47A(4) apply
• Part 2: what the company is charged on
• Part 3: the shareholder’s charge, and breach after a valid conversion (you are here)
• Part 4: what is lost, procedure and the 2025 Act

The decisions referred to throughout. Four Tribunal decisions are directly in point, and they are the only authority there is: Aravali Polymers LLP v. JCIT, ITA No. 718/Kol/2014, 27 June 2014 (Kolkata); ACIT v. Celerity Power LLP, ITA No. 3637/Mum/2015, 16 November 2018, (2019) 174 ITD 433 (Mumbai); ISC Specialty Chemicals LLP v. ITO, ITA No. 457/Mum/2025, 28 May 2025 (Mumbai); and Padmaja Rajesh Harve v. ACIT, ITA No. 5343/Mum/2025, 22 January 2026 (Mumbai). A Delhi Bench decision on the turnover threshold, AVA Landmark LLP, ITA No. 7233/Del/2018, 23 August 2022, is taken in Part 1, which introduces all five. No High Court and no Supreme Court has decided the merits of section 47(xiiib) or section 47A(4), so every proposition in this series rests on Tribunal authority or on the text.

What actually breaches the conditions after a valid conversion

What actually breaches the conditions after a valid conversion is worth stating, because this is where a compliant conversion goes wrong years later and nobody is watching for it. Clause (d) requires the aggregate profit sharing ratio of the erstwhile shareholders not to fall below fifty per cent “at any time” during five years. Admitting an outside investor breaches it. So does a partner retiring, or dying, if the vacated share passes outside the original group. So does gifting a profit share to the next generation, which is done for succession reasons with no thought of section 47(xiiib). Clause (f) is the three year bar on accumulated profits dealt with below. Clause (b), which requires the shareholders to become partners with capital contribution and profit sharing ratio in the same proportion as their shareholding, does not belong in this list, and it is worth saying why. It is tested at conversion, so a disproportionate allotment discovered years later does not breach a valid conversion; it shows the conversion was never eligible in the first place. That puts the file on route one, as Part 1 calls it, with the charge in the year of conversion rather than the year of discovery, and the difference between those two years is the whole of the limitation question.

Whether a breach brought about by operation of law, a death or an insolvency, is a breach at all is unanswered. The clause says the ratio shall not be less than fifty per cent at any time, without qualification as to how it came to be less, and nothing in section 47A(4) requires volition. The assessee’s answer is that a condition directed at the continuity of ownership cannot sensibly be broken by an event nobody chose, and that a construction producing a charge on the death of a partner should be avoided. There is no clarification and no decision.

The computation questions in the breach year are equally open, and they are not small. Which figures are used, those at conversion or those at breach? Is the holding period and therefore the rate fixed by the conversion date or the breach date, a question worth real money now that the regime changed on 23 July 2024? Does the shareholder’s charge revive as well as the company’s, or only the limb the deeming names? What happens to depreciation already claimed on a written down value carried across under Explanation 2C, to the section 35DDA amortisation and to a section 80-IA claim taken in the intervening years? And does the limited liability partnership, charged under section 47A(4) on a breach brought about by its partners, have any recourse against them? None of this has been litigated, and an adviser on a file of that kind, route two, which Part 1 defines, is reasoning from the text alone.

Where the money actually is: the shareholder’s charge

Padmaja Rajesh Harve v. ACIT, ITA No. 5343/Mum/2025, is a Mumbai Bench of Narender Kumar Choudhry JM and Bijayananda Pruseth AM, order by Pruseth AM, heard on 24 December 2025 and pronounced on 22 January 2026, for assessment year 2017-18. It is the most recent decision in this area and the most useful one to have on a file.

The facts are ordinary, which is the point. Harve Tube Tekniqs Pvt. Ltd. was incorporated on 20 May 2004 with a share capital of Rs. 1,00,000, being 10,000 shares of Rs. 10 each. The appellant and her husband held 5,000 shares each, worth Rs. 50,000 each. The company converted into a limited liability partnership on 15 September 2016. All assets and liabilities passed at book value, and the reserves and surplus were transferred to the partners’ current accounts in the limited liability partnership on 16 September 2016, the two partners being credited with Rs. 8,28,41,514 each. On 14 November 2016 each partner withdrew Rs. 7.14 crore from that current account.

Turnover in the preceding three years exceeded sixty lakh rupees and the assets exceeded five crore rupees, so clauses (e) and (ea) were not satisfied and the exemption was never available. The company itself recognised that: it treated the conversion as a transfer, declared the transfer amount as a short term capital gain, took the cost at the same book value, and arrived at nil.

The dispute was entirely at shareholder level, and it was not about whether there was a gain. Both sides agreed there was. It was about character. The Assessing Officer said short term, because the appellant had held the reserves in her capital account only from 15 September to 14 November 2016, two months. He therefore denied Rs. 50,00,000 of section 54EC relief and Rs. 5,80,11,910 of section 54F relief and disallowed the indexed cost of Rs. 67,188 that had been claimed, assessing total income at Rs. 8,56,83,688 against a returned Rs. 2,26,04,590. The assessed figure is the gross credit plus other income of Rs. 28,42,174, so no cost at all was allowed. The Commissioner (Appeals) agreed with him, reasoning that the reserves became the partner’s contribution on conversion, that the amount was “nothing but the bonus received by the assessee over and above her shares”, and that the holding period ran from 15 September to 14 November 2016.

The Tribunal reversed. The asset transferred was not the credit in the capital account. It was the shareholding:

Once the company was converted into LLP on 15.09.2016, there was transfer u/s 2(47) of the Act. As there were no other liabilities, only the shareholders had exclusive rights on the said reserves and surplus. Since the company or LLP had not claimed any benefit u/s 47(xiiib), the condition for maintaining the said reserves and surplus for a period of 3 years is not applicable in the instant case. The conversion from company to LLP on 15.09.2016 was the event when the transfer took place u/s 2(47) of the Act. Such transfer has triggered the taxability of capital gain in the hands of the shareholders who were holding the share of the erstwhile company from 20.05.2004 till 14.11.2016.

So the holding period the Tribunal worked with ran to 14 November 2016 and came to twelve years and five months, although on its own analysis the transfer occurred on 15 September 2016, which gives twelve years and nearly four months. Either way it is comfortably long term. The gain was long term, the cost of acquisition was the Rs. 50,000 actually paid for the shares in 2004, indexation was allowed on that figure, and sections 54F and 54EC were available to the extent of the purchase and the investment made.

Three things in that reasoning deserve to be separated out.

The event is the conversion, not the withdrawal. The transfer under section 2(47) occurred on 15 September 2016 when the shareholding was extinguished. The withdrawal two months later was the shareholder drawing on her own capital account and was not itself a transfer. Treating the withdrawal as the taxable event, as both the Assessing Officer and the Commissioner (Appeals) did, is what produced the short term characterisation, and it is wrong for the same reason the Tribunal gave: the asset that was transferred was the share.

Clause (f) does not bite where the exemption was never claimed. This is the sentence that does the most work in the order and it has had almost no attention, although it has to be read for what it is, a proposition stated in a case where no clause (f) breach was alleged and where the only dispute was long term against short term, so it decided nothing and was not argued: “Since the company or LLP had not claimed any benefit u/s 47(xiiib), the condition for maintaining the said reserves and surplus for a period of 3 years is not applicable in the instant case.” It is the Aravali and Celerity logic applied to clause (f) rather than to section 47A(4), and it is the answer to an officer who says that reserves may not be touched for three years after any conversion. The three year bar is a condition of an exemption. If no exemption is claimed, there is nothing to forfeit by paying out. The Revenue’s answer, which is not frivolous, is that eligibility under section 47(xiiib) is not elective: where the conditions were in fact satisfied the clause operates by force of statute whether or not anybody described it as a claim, so the three year bar applies of its own force. On facts like Padmaja’s, where clauses (e) and (ea) failed on the figures, that answer has nothing to bite on. On facts where the conditions were met and nobody said so in the return, it is a real argument.

The Tribunal relied on the Authority for Advance Rulings. Domino Printing Science PLC, 433 ITR 215 (AAR), had held that conversion of a company into a limited liability partnership constitutes a transfer of shares making the shareholder liable to capital gains tax where the conditions for tax neutral conversion are not met, because the shareholders’ rights are extinguished on conversion. Padmaja applied it. That is the only authority the order cites; it does not mention Celerity or Aravali at all, which is worth knowing if the order is being distinguished.

Now set the numbers side by side, because they are the argument for why this Part exists. At company level, book value against book cost, nil. At shareholder level, Rs. 50,000 of cost against a credit of Rs. 8,28,41,514, in each of two shareholders’ hands. Advice that reports the first figure and stops has not addressed the client’s exposure.

One caution before the order is quoted in a submission. The reserves figure appears three ways: Rs. 16,57,83,027 in the Tribunal’s recital of the authorised representative’s submission, Rs. 16,56,83,027 in its own finding of fact, and Rs. 16,56,83,028 as the balance sheet figure immediately before conversion. Twice Rs. 8,28,41,514 is Rs. 16,56,83,028, so the per partner credit reconciles with the balance sheet figure alone. The per partner figure itself appears two ways as well, as Rs. 8,28,41,414 in the Tribunal’s narration of the Assessing Officer’s findings and as Rs. 8,28,41,514 in its own finding and in the first ground of appeal. Use the balance sheet figure and note the discrepancies rather than picking one silently. The rest of the arithmetic reconciles exactly: Rs. 8,28,41,514 less Rs. 50,00,000 of section 54EC, less Rs. 5,80,11,910 of section 54F, less Rs. 67,188 of cost gives the Rs. 1,97,62,416 the appellant offered.

Long term or short term, and the reliefs that follow

The character question decided in Padmaja is the single largest variable in the shareholder’s exposure, and it turns on identifying the right asset.

If the asset is the share, the period of holding runs from acquisition of the share. For a promoter who incorporated the company years ago, that is long, the gain is long term, indexation was available on the original subscription amount under section 48 for a transfer before 23 July 2024, and the relief in section 54F is in play, and so was section 54EC in the years before it was confined to land or building. One limitation on section 54F should be stated at the outset, because it is routinely overlooked on these files: the section is available only to an individual or a Hindu undivided family. A shareholder that is not an individual or a Hindu undivided family gets the twelve and a half per cent rate from the long term point and nothing else; the position of a corporate and of a trust shareholder is taken separately below. Section 54EC was open to any assessee, but has been confined to a long term capital asset being land or building or both since assessment year 2019-20, so it is of no use on shares today whoever holds them. If the asset is treated as the capital account credit arising on conversion, the period of holding begins at conversion, the gain is short term on any realistic facts, indexation goes, and both reliefs go with it. The difference in Padmaja was the whole of the Rs. 50,00,000 section 54EC claim and the Rs. 5,80,11,910 section 54F claim.

The Tribunal’s analysis, that extinguishment of the shareholding on conversion is the transfer and the share is the asset, is the better view as a matter of section 2(47), and the contrary analysis has to explain what asset other than the share the shareholder parted with, which neither the Assessing Officer nor the Commissioner (Appeals) in Padmaja attempted. It should not be overstated. It is one Mumbai Bench order, it has not been tested on appeal so far as can be traced, and the only authority it rests on is a ruling of the Authority for Advance Rulings, which binds the applicant and the Commissioner in that case alone and is not precedent. Note too that Domino Printing is a double edged authority: the article relies on it for the character point, but its primary proposition is that there is a shareholder level charge at all, which is the Department’s case.

There is also a prior argument on the shareholder’s own computation, that no price was bargained for the extinguished shares so there is no full value of consideration for them either, with section 50D as the Revenue’s answer to it. That argument is taken in Part 2 alongside the company’s machinery defence, and it was not run in Padmaja, where both sides assumed a chargeable gain.

The Revenue’s own arguments are worth setting out, because they have not yet been run properly. What the shareholder received was rights under section 42 of the Limited Liability Partnership Act, so the consideration for his shares is the value of those rights rather than the reserves credit, which puts both the quantum and the character in issue. And the capital account credit can be presented as a distinct asset acquired on conversion, so that a withdrawal shortly afterwards is a dealing in a newly acquired asset. Neither argument was advanced in Padmaja.

Before the practical points, one more on cost, because Padmaja was the easy case: the shareholder had subscribed at incorporation and the cost was the Rs. 50,000 she paid. Most real shareholdings are not like that. Shares acquired before 1 April 2001 carry the option in section 55(2)(b) to substitute the fair market value on that date, and that option survives the withdrawal of indexation, because the Finance (No. 2) Act 2024 confined the second proviso to section 48 and left section 55(2)(b) untouched; in an old family company that substitution is frequently the largest number in the computation. Shares received by gift, will, inheritance or partition take the previous owner’s cost under section 49(1) and his holding period under Explanation 1(i)(b) to section 2(42A). Bonus shares have a nil cost under section 55(2)(aa)(iiia), which matters a great deal in a company that capitalised its reserves before converting, because the gain is then close to the whole of the credit. Shares received on an amalgamation take the cost of the shares in the amalgamating company under section 49(2), which is keyed to a transfer referred to in section 47(vii) and so depends on that clause’s own conditions having been satisfied, and shares taxed as a perquisite on exercise of an option take, under section 49(2AA), the fair market value already brought to tax.

Four practical points follow for a conversion that has already happened. First, the relief has to be claimed and the conditions in section 54F satisfied in the ordinary way, including the time limits running from the date of transfer, which is the date of conversion and not the date of any later withdrawal. The same was true of section 54EC in the years when it was available on shares. A shareholder who waits until he draws the money before investing may already be out of time. Second, section 54F carries its own deposit requirement in section 54F(4), which requires the unappropriated net consideration to be deposited before the return is furnished and not later than the section 139(1) due date. The Bombay High Court held that requirement mandatory in Rasiklal M. Parikh v. ACIT, Income Tax Appeal No. 314 of 2013, decided on 10 March 2017, and it is unforgiving; no special leave petition against it could be traced.

Third, and this changes the arithmetic for every current conversion, the reliefs and the rate are not what they were in Padmaja’s year. For transfers on or after 23 July 2024 section 112 charges long term capital gains at twelve and a half per cent, and the second proviso to section 48 now applies only to transfers before that date, so indexation is no longer available on unlisted shares at all. The saving in the second proviso to section 112(1)(a) does not help a shareholder on shares: it is confined to land or building or both acquired before 23 July 2024 by a resident individual or Hindu undivided family, and it is not an election but an automatic cap, the excess over the tax computed under the pre-amendment law being ignored. So the benefit of winning the long term point today is the twelve and a half per cent rate and section 54F, not indexation, and not section 54EC.

Fourth, where a shareholder is non resident the analysis changes again. Shares of an Indian company are situated in India, so the gain is within section 9(1)(i), and section 112(1)(c)(iii) charges a non resident on unlisted shares at twelve and a half per cent computed without the first and second provisos to section 48, which means neither the foreign exchange adjustment nor indexation. Treaty relief has to be considered on its own terms. The withholding position is a real gap in the machinery rather than a question of timing: on a conversion nobody pays the non resident anything, so there is no payer from whom tax can be deducted, and the charge has to be met by the non resident’s own return and advance tax. Where there is a remittance later, the Form 15CA and 15CB position has to be settled before it is made.

Behind all four points lies a prior objection the Department will take and the article should not hide: the shareholder did not receive any net consideration capable of being invested or deposited. He received a partnership interest. If that is right, section 54F(4) is impossible to comply with by definition and the six month window in section 54EC had no proceeds to run on. Padmaja allowed both reliefs on facts where cash was in fact drawn two months later, which is the very withdrawal the Tribunal held was not the transfer. That tension is unresolved.

One class of shareholder is worth separating out, because the conversion catches it on the wrong side of every rule. Employee options cannot survive into a limited liability partnership, because there are no shares for them to be options over, so an outstanding pool has to be exercised, cancelled or allowed to lapse before the conversion. On exercise the perquisite is charged under section 17(2)(vi) on the fair market value on the date of exercise less what the employee paid, that value being determined for an unlisted equity share by a merchant banker under rule 3(8)(iii) and for any other specified security under rule 3(9), with withholding under section 192 and, for an eligible start up referred to in section 80-IAC, the deferment in section 192(1C). The trap is what follows. An employee who exercises a month before the conversion holds shares acquired a month before the conversion, so his gain on the conversion is short term at his slab rate with no section 54F, while the promoter sitting beside him is long term at twelve and a half per cent. His cost is the fair market value already brought to tax, under section 49(2AA). And a payment to cancel the options instead is salary, not capital gains, so it is taxed at slab rates with no relief at all. There is no good answer to this; there is only doing it knowingly and early.

A shareholder that is not an individual needs separating out too. A holding company, a firm or another limited liability partnership gets the twelve and a half per cent rate and no section 54F, but it goes on to hold a partnership interest whose share of profit is exempt in its hands under section 10(2A), which is a benefit and belongs in the rate comparison set out in Part 2 rather than in the hazard column. A shareholder that is a private trust is a harder problem, and the difficulty is not a tax one: the Limited Liability Partnership Act admits only an individual or a body corporate as a partner, under section 5 read with the definition in section 2(1)(d), and a trust is neither, so a trustee can be a partner only in its own capacity as an individual or a body corporate. Since paragraph 2(2)(b) of the Third Schedule requires the partners of the limited liability partnership to comprise all the shareholders of the company and no one else, a trust on the register can make the conversion unavailable before section 47(xiiib) is reached at all.

Something else stops these conversions more often than any provision of the Income-tax Act. Foreign investment in a limited liability partnership is permitted under the automatic route only where the limited liability partnership operates in a sector in which one hundred per cent foreign direct investment is allowed under the automatic route and no foreign investment linked performance conditions attach, which is the test in the Department for Promotion of Industry and Internal Trade’s Consolidated FDI Policy Circular of 2020, effective 15 October 2020, in its paragraph on limited liability partnerships, the statutory basis being Schedule VI to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019; the paragraph number should be checked against the current circular rather than taken from commentary. The same test governs the conversion itself and any downstream investment. So a company carrying foreign investment in a conditioned sector cannot convert at all, whatever section 47(xiiib) says, and that is the first thing to check on a file with a non resident on the register. Where the company holds shares in an overseas subsidiary, those shares vest in the limited liability partnership with everything else and the overseas investment rules have to be checked for the new holder. This series otherwise assumes resident shareholders throughout.

Clause (f), and what counts as paying out accumulated profits

Clause (f) is the condition most likely to be breached by accident, because it bites on ordinary cash movements in the three years after a conversion that did qualify.

Its terms are narrow in one respect and wide in another. Narrow, because it is confined to amounts paid out of the balance of accumulated profit standing in the accounts of the company on the date of conversion. The accumulated profit is frozen at that date; profits earned by the limited liability partnership afterwards are not within it. Wide, because the payment may be made “either directly or indirectly”, and because it catches payment “to any partner”, not merely to an erstwhile shareholder.

Aravali shows how little it takes. The payment there was structured as interest free loans, not as a distribution. The Tribunal looked through the form on three facts taken together: the loans were interest free, they were made in the same ratio as profit sharing, and they came out of the reserves that had been the company’s accumulated profit. That combination “shows that the amount has been given directly to the partners out of the balance of the accumulated profits standing in the accounts of the Company on the date of conversion”. A loan account, a current account withdrawal and a drawing are all capable of being the same thing for this purpose. The caveat has to travel with the point: that Tribunal went on to hold that the exemption was never available to the assessee at all, so the finding shows what clause (f) reaches where it applies, not what happens after a valid claim, and there is still no decided case on the latter.

The defence, where the conversion did qualify, is to trace. If the limited liability partnership has earned profits of its own, and the payment can be shown to come out of those rather than out of the frozen opening balance, clause (f) is not engaged on its own terms. That requires the accounts to be kept so that the opening accumulated profit is identifiable and untouched, which is a bookkeeping discipline rather than a legal argument, and it has to be put in place at conversion rather than reconstructed afterwards.

Where the conversion did not qualify in the first place, Padmaja is the answer so far as clause (f) goes: there is no condition to breach, because there was no exemption. The caveat on the weight of that proposition is set out above and is not repeated.

That proposition is a complete answer to clause (f), and only to clause (f). It is not an answer to the two provisions dealt with next, and a client told that he may draw the reserves freely because no exemption was claimed has been given advice that stops short.

Sections 9B and 45(4): why Padmaja is no longer the whole picture

One thing should be settled before anything else, because it is the first question a reader of this section will ask. The conversion itself is outside both provisions. Section 9B and section 45(4) operate on the dissolution or the reconstitution of a specified entity, and a limited liability partnership coming into existence on a conversion is neither being dissolved nor being reconstituted. What the two provisions reach is what the partners take out afterwards.

Padmaja Rajesh Harve concerned assessment year 2017-18. The withdrawal of Rs. 7.14 crore by each partner in November 2016 was, on the law as it then stood, the partner drawing on his own capital account and nothing more.

That is no longer true. Section 9B was inserted and section 45(4) substituted by the Finance Act, 2021 with effect from 1 April 2021, so both apply from assessment year 2021-22. The substitution matters on older facts, because the sub-section that section 45(4) replaced dealt with distribution of capital assets on the dissolution of a firm and said something different. Section 9B deems the entity to have transferred a capital asset or stock in trade where a specified person receives it on dissolution or reconstitution, and charges the entity on fair market value. Section 45(4) charges the entity, on a reconstitution, on money and the fair market value of any capital asset received by a specified person, to the extent that it exceeds the balance in his capital account, computed without taking into account any increase on revaluation or on recognition of self generated goodwill or other self generated assets. Explanation 2 to section 45(4) makes that charge additional to section 9B rather than alternative to it. Section 48(iii) gives the attribution rule and rule 8AB works it, attributing the section 45(4) amount only where the excess relates to revaluation or to self generated assets or goodwill, with Form 5C to be filed by the section 139(1) due date. Rule 8AA(5) decides whether the amount is short term or long term. The charging provision has its own page at section 45(4).

For a conversion today, that changes the analysis of the very payment Padmaja was about. A partner who withdraws an amount credited to his current account in excess of his capital account balance, where the credit arose on a revaluation, exposes the limited liability partnership to a charge under section 45(4). Whether the ordinary crediting of the erstwhile company’s reserves to partners’ current accounts on a book value conversion produces such an excess will depend on how the accounts are drawn, which is a reason to draw them carefully rather than a reason to assume the question away.

So the position on withdrawing reserves after a non-compliant conversion is now in two parts. Clause (f) does not bite, on Padmaja, because there is no exemption to forfeit. But the withdrawal has to be tested separately under sections 9B and 45(4), which do not care whether section 47(xiiib) was ever in play. The first point is an answer about the exemption; it is not an answer about the charge.

What happens to the accumulated profits

The reserves of the company do not disappear on conversion. They are credited to the partners, and there is an obvious alternative characterisation of that event which the Department has not yet run but which an article on this subject has to address.

Section 2(22)(a) treats as dividend any distribution by a company of accumulated profits, whether capitalised or not, if the distribution entails the release of the company’s assets to its shareholders. Section 2(22)(c) treats as dividend any distribution to shareholders on liquidation, to the extent attributable to accumulated profits immediately before liquidation. If either applied, the shareholder would be charged on the reserves as dividend income at slab rates rather than as a capital gain at the rates in section 112, and sections 54F and 54EC would be irrelevant.

The textual answer is that clause (c) is keyed to liquidation and a company that is dissolved on conversion under section 58 of the Limited Liability Partnership Act is not in liquidation, so clause (c) does not arise, and section 46, which is keyed to liquidation throughout and whose sub-section (2) merely measures the shareholder’s charge by reference to the amount assessed as dividend under section 2(22)(c), does not arise either. Clause (a) is harder to dismiss, because it is not keyed to liquidation; the answer there is that there is no distribution by the company at all, the reserves passing to the limited liability partnership with everything else by statutory vesting and reaching the partners only through the partnership’s own accounts.

Both readings look right, and no decision either way could be located. They are worth stating on the file nonetheless, because the characterisation question decides the rate, and because the Padmaja analysis, which treats the credit as consideration for the shares, and the dividend analysis, which treats it as a distribution of profits, cannot both be correct about the same money.

One clause of section 2(22) does bite on these files, and it bites before the conversion rather than on it. Where a closely held company makes a payment by way of a loan or advance to a shareholder who is the beneficial owner of shares carrying not less than ten per cent of the voting power, or to a concern in which such a shareholder is a member or partner and in which he has a substantial interest, section 2(22)(e) deems it a dividend to the extent to which the company possesses accumulated profits. A company whose reserves are large enough to make a conversion worth doing has very often been lending against those reserves informally for years, and the partners’ loan accounts in the new limited liability partnership are frequently the continuation of exactly that. It is the first thing an officer looking at the conversion will see in the company’s balance sheet.

Which assessee bears the charge depends on the year, and this is where most advice goes wrong. A loan made before 1 April 2018 was assessable in the shareholder’s hands, because the Explanation to section 115Q excluded sub-clause (e) from Chapter XII-D and section 10(34) exempted only dividends referred to in section 115-O. A loan made between 1 April 2018 and 31 March 2020 was charged on the company, and charged at thirty per cent under the proviso to section 115-O(1) rather than at the headline fifteen, with the receipt exempt to the shareholder. A loan made on or after 1 April 2020 is assessable in the shareholder’s hands again, at his slab rate, section 115-O having been confined to dividends paid on or before 31 March 2020 and the exemption withdrawn by the Finance Act, 2020. Those are precisely the years in the look back period of a conversion done now, so the limitation position for each has to be checked on its own and separately from the conversion year.

The assessee’s answers are real and should be run in order. The shareholder limb needs beneficial ownership of ten per cent of the voting power, and the concern limb needs both membership or partnership and a substantial interest, so an advance to a director who is not such a shareholder is outside the clause altogether. The charge is capped at accumulated profits as they stood when each advance was made, which for a company that has been lending for years is frequently exhausted long before the last advance. Sub-clause (ii) of section 2(22) takes out a loan advanced in the ordinary course of a business in which the lending of money is a substantial part. A trade advance in the nature of a commercial transaction is not an “advance” within the clause on the Board’s own view in Circular No. 19/2017 dated 12 June 2017, under which officers were directed not to press the point. And sub-clause (iii) prevents a second charge on repayment and re-advance, to the extent the later dividend is set off against the sum previously treated as a dividend.

There is also a point here in the company’s favour, which belongs with the reasons for converting rather than with the hazards: section 2(22) applies to a company, so advances by the limited liability partnership to its partners after conversion are outside clause (e) entirely. For a closely held company that has spent years lending against its own reserves, that relief sits alongside the rate as a reason for converting, and it is rarely quantified.

Unexplained credits: sections 68 and 69, which the first balance sheet invites

Two exposures arise from the mechanics of the conversion rather than from any provision about it, and both are met in practice more often than the capital gains argument.

The first is the limited liability partnership’s own opening balance sheet. The partners’ capital and current accounts are opened with credits running to crores of rupees, in an entity that has no trading history of its own and no explained source for them in its own books. An Assessing Officer looking at a first return of that shape reaches for section 68 as a matter of routine. The answer is complete and is a matter of law, the statutory vesting under section 58(4) of the Limited Liability Partnership Act together with the company’s audited accounts at the date of conversion, but it is an answer that has to be documented at the time. A reconstruction attempted four years later from incomplete records is a much weaker thing than the audited closing balance sheet, the conversion forms and a reconciliation prepared on the day.

The second is that conversion does not launder the company’s own history. Unexplained cash credits, share capital or premium in the company remain assessable in the company’s own years, under section 68 with its proviso on share capital and share premium where the assessee is a company in which the public are not substantially interested, and unexplained investments remain within section 69. The limited liability partnership can be reached for the resulting demand through section 170, and the partners through section 167C where recovery fails. A conversion undertaken to put a disputed period behind the client does not do that.

The open questions on the shareholder and on breach

No court has decided the merits of section 47(xiiib) or section 47A(4), so nothing below is settled. What follows is the state of the argument on each point, with the Revenue’s case put as it would be run. The questions keep the numbering they carry across the whole article, so the sequence here is not consecutive, and the list is not closed.

12. Does clause (f) bite where no exemption was claimed? For the assessee: Padmaja, in terms. For the Revenue: the clause operates by force of statute where the conditions were in fact met, and nothing turns on whether anyone called it a claim. Padmaja decided it in a case where no clause (f) breach was alleged.

13. Is clause (c) spent at conversion? Clause (c) requires that the shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the limited liability partnership; Part 1 sets out all seven conditions. For the assessee: Aravali, because the company no longer exists for its shareholders to receive anything. For the Revenue: the clause fixes the persons by their status immediately before conversion, and reading it as spent lets it be circumvented by paying a day later. Obiter in a case the assessee lost on another condition.

17. Is a breach brought about by operation of law a breach? For the Revenue: clause (d) says the ratio shall not be less than fifty per cent at any time, without qualification as to how it came to be less, and nothing in section 47A(4) requires volition. For the assessee: a condition directed at continuity of ownership cannot sensibly be broken by an event nobody chose, and a construction that charges tax on the death of a partner should be avoided. No clarification and no decision, and this is the most practically important of the route two questions.

18. On route two, which figures, which date, and does the shareholder limb revive? For the assessee: the charge is on the gain that was not charged at conversion, so the figures and the holding period are those at conversion, and section 47A(4) names the limb it deems rather than reviving both. For the Revenue: the deeming operates in the breach year, which is the year the income is deemed to arise, so the rate regime of the breach year applies; and the words “as the case may be” distribute the charge rather than confine it. Nothing has been litigated, and the choice of date is worth real money now that the regime changed on 23 July 2024.

On a live file

Where the shareholders are taxed. Work from the original cost of the shares, or the fair market value on 1 April 2001 under section 55(2)(b) where they were acquired before that date, and from the original date of acquisition, not from the conversion date. For a transfer on or after 23 July 2024 the rate is twelve and a half per cent and there is no indexation on unlisted shares, so the benefit of the long term point is the rate and, for an individual or Hindu undivided family shareholder only, section 54F; section 54EC is not available on shares at all. Time any section 54F investment from the date of conversion, not from a later withdrawal, and address the section 54F(4) deposit. Test any withdrawal from the limited liability partnership separately under sections 9B and 45(4), which the clause (f) point does not answer. Where a shareholder is non resident, settle section 112(1)(c), the treaty position and withholding before the conversion.

Concordance for the provisions in this Part

Income-tax Act, 1961	Income-tax Act, 2025
Section 54F	Section 86
Section 54EC	Section 85
Section 112	Section 197
Section 55(2)(b)	Section 90(9)
Section 9B	Section 8
Section 45(4)	Section 67(10)
Section 2(22)(e)	Section 2(40)(e)
Sections 2(22)(a) and 2(22)(c)	Sections 2(40)(a) and 2(40)(c)

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Previous: Part 2: what the company is charged on. Next: Part 4: what is lost, procedure and the 2025 Act.

This article is Part 3 of four on the conversion of a private company into a limited liability partnership where section 47(xiiib) is not satisfied. It states the position on the date shown above and is written for general guidance. It is not advice on any particular conversion. Every decision directly on section 47(xiiib) and section 47A(4) discussed here is a Tribunal decision, where the position can change. Figures and dates taken from the orders are noted where the orders themselves are inconsistent.

This note is general commentary on the law as at 27 October 2026 and is not advice on any matter. The position in a particular case depends on its own facts.